The bond market is sending a warning that extends well beyond fixed income. The 10-year Treasury yield climbed to around 5.15% Thursday, its highest level since 2007, while the 30-year yield touched 5.45%, its highest since 2004.
For ETF investors, rising yields are increasing rate sensitivity across portfolios, extending beyond traditional bond ETFs to growth stocks and other valuation-sensitive assets.
5% Treasuries Raise the Hurdle
The latest yield surge comes as U.S. economic activity remains strong. A flash composite PMI reading of 58.4 pointed to the fastest expansion in business activity in more than five years.
Giuseppe Sette, co-founder and president of Reflexivity, said strong growth naturally puts upward pressure on nominal yields. “If real growth is strong, one has to expect nominal bond rates to adjust. Keep calm and carry on, this is just how bonds are supposed to work.”
But higher yields also make equity valuation more challenging.
David Miller, portfolio manager of the Strategy Shares Gold Enhanced Yield ETF (BATS:GOLY) and CIO at Catalyst Funds, said higher long-term rates increase the discount rate applied to future earnings.
“Higher long-term rates raise the discount rate on future earnings and give investors a much more compelling risk-free alternative, which can put particular pressure on richly valued growth stocks while favoring companies with strong current cash flows, pricing power and resilient balance sheets,” said Miller.
That puts growth-heavy ETFs such as Invesco QQQ Trust (NASDAQ:QQQ) in focus. Companies whose biggest earnings are expected years into the future tend to be more sensitive to changes in the discount rate.
You May Own More Duration Than You Think
Mark Malek, CIO at Siebert Financial, said investors often underestimate how much “duration” they own through equities. “Long-term bonds aren’t the only rate-sensitive assets — high-flying growth stocks whose biggest profits are years away can behave a lot like 30-year bonds.”
The contrast is particularly clear with iShares 20+ Year Treasury Bond ETF (NASDAQ:TLT). The ETF had an effective duration of about 14.96 years and an average yield to maturity of 5.45% as of Thursday.
Higher yields can eventually mean higher income for new bond buyers, but they also pressure the prices of existing long-duration securities.
Byron Anderson, head of fixed income at Laffer Tengler Investments, expects yields to remain elevated. “We continue to normalize the yield curve, plain and simple. We are firmly set up for higher yields in this environment.”
Short-Term Treasuries Become a Bigger Competitor
At the other end of the duration spectrum are ETFs such as iShares 0-3 Month Treasury Bond ETF (NYSE:SGOV). SGOV had an effective duration of just 0.10 years as of Thursday, limiting its sensitivity to interest-rate changes.
Malek argues that the return of meaningful Treasury yields changes the opportunity cost of taking risk. “Cash and short-term Treasuries have become legitimate portfolio competitors again.”
Natalia Lojevsky, managing director at CIFC Asset Management, said the latest policy shift and market reaction suggest investors are reassessing the rate level needed to keep inflation under control.
That leaves ETF investors questioning how much rate sensitivity they want across stocks, long-duration bonds and other risk assets.
As Malek put it: “Businesses are cooking. Households are sweating.”
The economy may be strong, but at 5%-plus Treasury yields, investors must pay much closer attention to what that strength costs their portfolios.
Photo: Shutterstock
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