What Happens to the S&P 500 if the 10-Year Yield Cracks 5%

The 10-year Treasury yield is heading upward, like a hiker climbing on a mountain. And like a hiker, the yield reaches significant points—or levels.

For the 10-year, the next major key level is 5%—and Wall Street definitely won’t be applauding the milestone. Stocks would take a hit.

Today, the yield stands at just over 4.6%—almost a full percentage point higher than its February low of 3.8% and change. Driving it higher are two things: Hotter-than-expected inflation and the expectation that the Federal Reserve won’t cut short-term interest rates soon.

At 4.6%, the yield is certainly within striking distance of 5%. Even breaking above 4.7% would send a clear signal that the march isn’t over, writes John Kolovos, chief technical strategist at Macro Risk Advisors.

The yield rose to roughly 4.7% twice in April. Then, it promptly dropped because too many buyers showed up, sending the price of the bond up and the yield down.

This time, if sellers are front and center—they would push the price down and yield up—the yield would drift higher. A 5% yield would be right there.

For the stock market, that’s a problem.

Right now, the S&P 500 is almost 3% below its record intraday high after spiking on Friday. It is gaining again after a big drop a couple of weeks ago in no small part because stock traders are fairly calm for the moment—they still think the 10-year yield can fall if it doesn’t breach 4.7%.

But get ready: A yield of 4.7% or higher could very well ruin Wall Street’s good move and drive equities lower.

A higher yield would raise the cost of borrowing—for consumers and businesses—making it more difficult for them to spend. The upshot of that: fairly slow economic growth, which could prompt analysts to reduce their earnings forecasts for companies.

A related concern is stock valuations.

Higher yields on government bonds are appealing to investors who are jittery about steep valuations.

Right now, the S&P 500 trades at about 20 times analyst’s profit expectations for the coming 12 months, which means the earnings that investors receive by owning the index would yield them 5%—barely, if any, additional return versus a bond.

Stockholders want a higher rate of return as compensation for the added risk they’re taking. That’s why any meaningful move higher in the 10-year should trigger a selloff.

If the yield rises above 4.7%, the S&P 500 should fall to 4800 from its current level of about 5100, based on the correlation between the index and the bond yield in the past few years, writes Kolovos. A yield above 5% would send the S&P 500 to about 4500, a 12% drop from its current level.

Watch that yield.

Write to Jacob Sonenshine at [email protected]