In a year where the 10-year U.S. Treasury Yield started at 0.93%, peaked at 1.74% in the middle of March, and closed at 1.33% as of September 13, 2021, the stock market and the bond market attempt to tell two different stories. For the year, the Standard and Poors 500 and the NASDAQ Composite are up about 20% and 19%, respectively, with the Dow Jones Industrial Average and the Russell 2000 Index up about 14%. Visualizing the four indices against each other presents an image of movement up and to the right compared to a more rocky pattern set forth by the 10-year U.S. Treasury Yield.
I’m not a bond guy and frankly don’t entirely understand the complexity of the bond or fixed income market, but from the very little that I know, the 10-year U.S. Treasury Yield serves as a barometer to understand future cash flows. According to the Corporate Finance Institute, “The 10-year note is what most professionals in investment banking, equity research, corporate development, financial planning and analysis (FP&A), and other areas of finance use as the risk-free rate of return.” The name implies the meaning. The 10-year U.S. Treasury Bond is considered the safest investment vehicle due to the overpowering and pedestal-like admiration placed on the fabric of the U.S. financial systems.
Derived from that admiration is a devotion to the 10-year U.S. Treasury Yield, allowing for appropriate & personal risk assessment and application of capital for appreciation. By investing in a U.S. treasury bond, you essentially present the principal to the U.S. government in exchange for coupon payments and return of the principal at the end of the term, i.e., ten years. In an article titled, Why Bond Prices Go Up and Down, Annette Thau for the American Association of Individual Investors provides a synopsis of the bond prices using the 30-year U.S. Treasury Yield and $1000. Extrapolating her guidance to the historical performance of the 10-year U.S. Treasury Yield from 1962, the last time a 10-year U.S. Treasury bond could have been sold without a significant markdown would be June 1984.
The following chart from FRED, Federal Reserve of St. Louis, charts the 10 Year Treasury Constant Maturity Rate starting January 1962. The grey shaded areas identify periods of economic recession. As we approach the 60-year mark, eight periods of economic recession are visible, with three of the eight occurring in the last 20 years.
Zooming into the period starting 2000, the 10-year U.S. Treasury Yield has dropped about 500 percentage points from 6.68% to the 1.33% as of market close on September 13, 2021. Applying Dr. Thau’s logic to this situation, a 10-year Treasury Bond would have suffered a significant markdown between the first decade compared to the second decade. The 10-year U.S. Treasury Yield dropped about 300 percentage points in the former decade, compared to the roughly 200 percentage points drop in the second decade of the 21st century. Within the last twenty years, or as a matter of fact since 1962, a fiscally and monetarily stimulated U.S. economy with copious debt derives the current 10-year U.S. Treasury Yield in a range never seen before. If the 10-year U.S. Treasury Yield or the “risk-free” rate has declined almost 1400 percentage points since its peak in 1981, it is easy to assume how and why the stock market has outperformed.
Financial media and market participants award an almost symbiotic status between Interest rates and Tech Stocks. While the 10-year U.S. Treasury Yield serves as a “risk-free return” metric, it also serves as a discount rate- a rate of return used to discount future cash flows to present value. Lei Qiu, Portfolio Manager & Senior Research Analyst at AllianceBernstein, eloquently explains the interaction between the 10-year U.S. Treasury Yield and Tech Stocks in a blog post titled Debunking the Myths of High-Priced Tech Stocks, stating, “High-growth companies tend to have greater income streams coming from future revenue and earnings. So, when rates remain low, income streams benefit from lower discount rates, helping to boost stock prices.” What Ms. Qiu offers is a synthesized approach to understanding the nuanced interaction between the 10-year U.S. Treasury Yield and Tech Stocks.
Most market participants would be familiar with the Standard and Poor’s 500 and the NASDAQ Composite Index. While the Standard and Poor’s 500 is narrow, the NASDAQ Composite Index is not. Drawing attention, not to the surface, but a subset, the Standard and Poors Global 100 and the NASDAQ-100, the benefit of a subsiding 10-year U.S. Treasury Yield is evident. Why the Standard and Poor’s Global 100 and the NASDAQ-100? Because both indices track 100 of the most prominent companies by market cap, but with a catch. The NASDAQ-100 is skewed more towards technology stocks, compared to the Standard and Poor’s Global 100. As of June 30, 2021, the NASDAQ-100 was 55.45% Technology Stocks, with Consumer Discretionary second at 22.11% and Health Care at 6.71%. Compare that to the Standard and Poor’s 100, where Technology was 29.61%, Consumer Discretionary was 14.1%, and Health Care was 12.2%. Maintaining the skew towards technology stocks offers insights into the outperformance of Technology Stocks, mainly based on the interaction between the Standard and Poor’s Global 100 and the NASDAQ-100 indices.
Evident is the outperformance of Tech Stocks under a depressed 10-year U.S. Treasury Yield. Consider the following; the NASDAQ-100 outperformed the Standard and Poor’s Global 100 by almost $600 starting 2005, $400 & $130 starting 2010 & 2015, respectively. For the period starting 2005, i.e., the first chart, apply your attention to 2008. Visible is the separation of the NASDAQ-100 compared to the Standard and Poor’s Global 100. Moreover, if you notice the Average 10-year U.S. Treasury Yield for the fifteen years, post-2008, the 10-year U.S. Treasury Yield barely trended above the average. If one forecasted the 10-year U.S. Treasury Yield to remain low for a long time and translated it to investment in Tech Stocks, positive and extraordinary returns would have compounded over time. The third chart, i.e., the period starting 2015, shows the average 10-year U.S. Treasury Yield trends in the 2% mark. Extrapolating it further, if the current 10-year U.S. Treasury Yield gains about 70 basis points, the 10-year U.S. Treasury Yield would be ludicrously below the historical 10-year U.S. Treasury Yield. While this could have implications for current projections, I think a more abrupt double-digit percentage point move would disrupt fundamentals more.
As the 10-year U.S. Treasury Yield trended above the average, the NASDAQ-100 started underperforming the Standard and Poor’s Global 100. A transition of the current 10-year U.S. Treasury Yield to the Average 10-year U.S. Treasury Yield translated to a pickup in the NASDAQ-100. While I do not think that the 10-year U.S. Treasury Yield is the definitive metric to understand performance, it is a metric to understand fundamentals.
Understanding a significant contributor to the success of U.S. markets were Tech Stocks such as Apple Inc (NASDAQ: AAPL), Amazon.com Inc (NASDAQ: AMZN), Alphabet Inc (NASDAQ: GOOG, GOOGL), Facebook Inc (NASDAQ: FB), Netflix Inc (NASDAQ: NFLX), Adobe Inc (NASDAQ: ADBE) is vital because accompanying the ticker symbol for the company is a NASDAQ listing and not NYSE. These companies are relatively new, and one would like to think still growing. While a low-interest-rate environment could have materially benefited their fundamentals, these companies have delivered definitive earnings and results in overtime to justify their valuations as well. A rising 10-year U.S. Treasury Yield would mark down future cash flows, but it is worth pondering whether those cash flows would be lower if the company can maintain even single-digit growth rates. Reverting to the 10-year U.S. Treasury Yield hovering around 2-3% of the last decade, as seen in chart 2, would be different and untraditional, but expecting Tech Stocks to underperform entirely would be shortchanging some of their deliverables.