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Here's one emerging threat that could derail the bull run

The New York Times logo The New York Times 9/26/2018 By PETER EAVIS

Nothing so far has succeeded in ending the bull run in stocks that began nearly a decade ago.

The rally survived the sluggish economy in the aftermath of the financial crisis, the European debt crises, fiscal battles in Washington, the oil bust, concerns about China’s growth and, most recently, President Trump’s trade war.

Now the stock market faces a more prosaic but nonetheless powerful threat: increasingly attractive returns on government bonds.

For years, yields on Treasuries were so low that investors had an incentive to buy stocks in the hope of higher returns. Yields are still quite low by historical standards, but they have been rising in recent weeks, and they could go even higher if the Federal Reserve keeps raising its target interest rate. (An increase was announced on Wednesday.)

The more yields go up, the more likely investors will choose the relative safety of Treasuries — and that could cause the stock rally to stall. Warren E. Buffett has often commented on the connection between government bond yields and stock market investments. In a 1999 article in Fortune, Mr. Buffett said, “The rates of return that investors need from any kind of investment are directly tied to the risk-free rate that they can earn from government securities.”

The yield on the 10-year Treasury note has risen to 3.1 percent, from 2.4 percent at the end of last year, and analysts expect the yield to climb to 3.42 percent by the end of 2019, according to a Wall Street Journal survey. That yield is still far from beating the stock market’s recent annual performances. The Standard & Poor’s 500-stock index rose 19 percent last year and is up 9 percent this year. But buying a 10-year Treasury today would provide its holders with 3 percent a year for a decade with virtually no risk of losing any money in the process.

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Such a return might seem particularly attractive to investors who believe the stock market is expensive and is vulnerable to a sell-off. One way to make that comparison is to look at the difference between the yield on the 10-year Treasury and the “yield” on the stock market, measured by dividing the historical yearly earnings of the S. & P. 500 companies by the value of the index. When the earnings yield is substantially higher than the 10-year Treasury yield, investors are more likely to favor stocks. The difference has narrowed. It’s now 1.83 percentage points, well below the 2.88-point average of the past three years.

If companies’ profits continue to grow strongly, the earnings yield will rise and stocks will look more attractive compared with government bonds. But corporate earnings growth is expected to slow next year. And the trade war may cause corporate profits to moderate even more. In that case, the difference between the 10-year yield and the earnings yield would shrink even more. Investors may be more tempted then to shed stocks and put more money into bonds.

There is a major reason this bearish outcome may not occur. Profits could be stronger than analysts are forecasting.

But if companies disappoint investors with lackluster profits, the federal government has an investment it is eager to sell them.


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