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The Tell: Rising bond yields ‘diminish’ but don’t ‘destroy’ case for U.S. stock market: RBC

Analysts at RBC Capital Markets have trimmed their 2022 target for the S&P 500 index, citing the recent rise in bond yields as the Federal Reserve tightens its monetary policy. 

They now expect the S&P 500 will end the year at 4,860, down from their previous target of 5,050, according to a research note Monday from analysts led by Lori Calvasina, head of U.S. equity strategy. Around midday Monday, the S&P 500
SPX,
-0.66%

was off 0.9% at around 4,235, extending Friday’s selloff.

“The recent move up in bond yields was the biggest contributor to the downward revision to our forecast,” the RBC analysts said in the report. “The recent rise in 10-year yields has diminished, but not totally destroyed, the case for US equities for the remainder of the year.”

The U.S. stock market sank last week amid concern over the Fed’s path of monetary tightening this year, as the central bank aims to tame high inflation in part through interest rate increases. Bond yields have recently jumped in anticipation of rate hikes by the Fed, taking “a bite” out of equity valuations, though the S&P 500 should still end 2022 with “modest gains,” according to RBC.

Read: What’s next for the stock market as investors grapple with Fed near ‘peak hawkishness’

So far this year, the S&P 500 has dropped more than 11%, while the STOXX Europe 600 index
SXXP,
-1.81%

is down almost 9%, FactSet data show, at last check. London’s FTSE 100 index
UKX,
-1.88%

was showing a year-to-date loss of less than 0.1% after trading sharply lower Monday.

Key Words: Market ‘not seeing a low yet,’ says Morgan Stanley’s Wilson after ‘ominous’ signal late last week

“Recession expectations have risen much faster for Europe than the US,” the RBC analysts wrote. “For now, the Russia/Ukraine war as well as COVID – which is hitting China hard – are being viewed by equity market participants as having fewer reverberations in the U.S.”

In Asia, the Shanghai Composite index
SHCOMP,
-5.13%

has plunged 19.5% so far this year, FactSet data show. The index closed 5.1% lower Monday.

See: Here’s why a further drop in China’s yuan could lead to another round of shockwaves in markets

“U.S. equities are benefiting from safe haven status relative to other geographies,” the RBC analysts said. They have “outperformed non-US equity since last summer, with leadership seeing another leg up in late February as Russia invaded Ukraine.”

In the bond market, the yield on the 10-year Treasury note
TMUBMUSD10Y,
2.802%

was trading about 12 basis points lower around midday Monday at 2.78%, FactSet data show. The 10-year yield has climbed from around 1.5% at the end of last year, according to Dow Jones Market Data. Bond yields and prices move in opposite directions. 

“The dividend yield appeal of the S&P 500 has dwindled, with just 18% of stocks having a dividend yield above the 10- year Treasury yield as of mid-April,” the RBC analysts said.  That suggests “more muted returns” for the S&P 500.

In midday trading Monday, the S&P 500 was not far off its closing low of 4170.70 hit March 8. The RBC analysts said the S&P 500 may have “largely baked in Fed tightening” at the March 8th low, assuming no recession follows.

“Higher bond yields are a problem for US equities but not a reason on their own to look for a down year,” the analysts wrote. “We continue to be more intrigued with Growth
RLG,
-0.39%

than Value
RLV,
-1.51%

going forward, though we’d be highly selective in our Growth exposure.”

Need to Know: The stock market selloff still has another 20% to go, says the godfather of liquidity

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