LP L FINANCIAL R E S E AR C H

Weekly Market Commentary

June 1, 2009
v4

As Rates Spring Back, Is a Weak Summer

for Stocks Ahead?

Government bond yields have moved sharply higher in 2009—although

Jeffrey Kleintop, CFA
they remain at historically low levels. After reaching a low of 2.05% on
Chief Market Strategist
LPL Financial December 30, 2008 the yield on the 10-year Treasury note climbed to a high
of 3.74% last week, reversing the decline in yields that took place during the
Highlights fourth quarter. The price of the 10-year T-note, which moves in the opposite
direction of the yield, has plunged, resulting in about a 25% loss over the
Government bond yields have moved sharply
same period. Late last year, we recommended avoiding Treasuries and wrote
higher in 2009. Such a rise in rates during recovery
from recession is usually a sign that markets
about a developing bubble in them as investors sought safe haven from
are beginning to broadly expect the recession is the financial crisis. Now that the direction of government interest rates has
coming to an end and a return to growth is on clearly turned around, what does the rise in Treasury yields mean for the
the way. economy and markets?

However, the healing process underway in the The healing process underway in the United States is driven in part by low
United States is partly dependent upon low interest rates that contribute to low mortgage rates, low cost of capital
interest rates that contribute to low mortgage for businesses, and the low cost of government debt used to finance
rates, low cost of capital for businesses, and the stimulative policy actions. Fortunately, mortgage rates and corporate bond
low cost of government debt used to finance yields have not risen significantly; credit spreads have contracted, allowing
stimulative policy actions. these important rates to remain largely unchanged. In fact, Baa-rated
While the rise in Treasury yields is a normal and corporate bond yields are about that same as they were on December 30,
healthy part of the healing process in the economy 2008 when Treasury yields were at their low, and the average rate on a
and markets, a further rise in the 10-year T-note conventional 30-year fixed rate mortgage remains at about 5%.
yield over 4% this summer may act as a
Rising interest rates are common near the end of recessions, as in fact
negative factor.
happened with each of the past five recessions. As you can see in Chart 1,
the magnitude of the rate bounce is often related to the length and severity
of the recession. The largest rise was in 1983 following the back-to-back
1 The Yield on the 10-Year Treasury Note with End recessions and inflation spiral of the late 1970s and early 1980s. The rise
of Recession Rate Bounces Noted in rates is usually a sign that markets are beginning to broadly expect the
recession is coming to an end and a return to growth is on the way.
18
16 The bounce in yields this year has been bigger than average. However,
14 given the severity of the recession and the fact that rates fell to just 2%, the
12 sharp rise is not surprising. Based on the path of prior yield bounces, when
10 after 90 trading days, the yield bounce has typically peaked, the current
8 episode may have now run its course. Chart 2 shows the current bounce in
6 yield on the 10-year T-note since the low on December 30, 2008 relative to
4 the average bounce of the prior five recessions. In the past 20 trading days,
2 the yield has broken away from the average to total a rise of about 170 basis
0 points since the low, compared to the average of about 100 bps by
1962
1966
1970
1974
1978
1982
1986
1990
1994
1998
2002
2006

this point.
Source: LPL Financial, Bloomberg,
National Bureau of Economic Research

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 W E E KLY MARKE T COMME N TAR Y

2 Change in Yield on 10-Year Treasury Note for On average, stocks have posted slight gains in the past during the bounce in
Current Bounce Compared with Prior 5 Recession yield. Chart 3 reflects the average performance of the S&P 500 along with
Bounces the change in yield on the 10-year T-note over the bounces of the past five
recessions. Returns average only a few percentage points over the 90 days
Average Yield Change from Low for Past Five Recessions
Change in Yield Since 12/30/08
following the low in yield. Returns were modest in all cases.
2.00
1.80 The bounce in yield since December 30, 2008 has coincided with a wide
1.60 range for the stock market, yet the S&P 500 has posted a net gain similar
1.40 to the historical average for this point in the bounce. The S&P 500 fell 25%
1.20
1.00 during the two months that followed the low point in yield, followed by a
0.80 rebound that has resulted in a modest gain since the low point in yield.
0.60
0.40 While the rise in Treasury yields is a normal and healthy part of the healing
0.20 process in the economy and markets, a further rise in the 10-year T-note
0.00
0 30 60 90 120
yield over 4% this summer may act as a negative factor. The modest returns
Trading Days from Low in 10-Year T-Note Yield for stocks during similar yield bounces in the past highlight the fact that the
Source: LPL Financial, Bloomberg bounce in yield does not merely signal better economic prospects—if that
were true stocks would have posted more powerful gains. Rising yields
provide less stimulus to the economy and may reflect the impact of the rise
3 Average of Prior Five Recessions Change in Yield in the budget deficit as tax revenues fall while government spending rises.
and S&P 500 Performance from Recession Low Above 3.7% on the 10-year T-note appears to be the range where mortgage
Yield and corporate bond yields began to rise in tandem with Treasuries, weighing
on performance for both bonds and stocks. Fear that yields may continue to
Average Yield Change from Low for Past Five Recessions
Average Change in S&P 500 from Yield Low Point for
trend upward may keep a lid on the stock market
Five Recessions
2.00 6.0%
IMPORTANT DISCLOSURES
1.75
1.50
The opinions voiced in this material are for general information only and are not intended to provide specific
4.5%
1.25 advice or recommendations for any individual. To determine which investment(s) may be appropriate for you,
1.00 3.0% consult your financial advisor prior to investing. All performance reference is historical and is no guarantee of
0.75 future results. All indices are unmanaged and cannot be invested into directly.
0.50 1.5% Investing in international and emerging markets may entail additional risks such as currency fluctuation and
0.25
political instability. Investing in small-cap stocks includes specific risks such as greater volatility and potentially
0.00 0.0%
less liquidity.
-0.25
-0.50 -1.5% Stock investing involves risk including loss of principal Past performance is not a guarantee of future results.
0 30 60 90 120
Investing in alternative investment may not be suitable for all investors and involve special risks such as risk
Trading Days from Low in 10-Year T-Note Yield
associated with leveraging the investment, potential adverse market forces, regulatory changes, potential
Source: LPL Financial, Bloomberg liquidity. There is no assurance that the investment objective will be attained.
Small-cap stocks may be subject to higher degree of risk than more established companies’ securities. The
illiquidity of the small-cap market may adversely affect the value of these investments.
Alternative investment mutual fund strategies are subject to increased risk due to the use of derivatives and/
or futures.

This research material has been prepared by LPL Financial.

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