Bond Yields and the Flourishing of Growth Stocks

2 Mins read

Bond yields have seen a recent decline, and there is a strong likelihood that this trend will continue. This decrease in yields often leads to the flourishing of growth stocks.

The 10-year Treasury yield, previously at a 16-year high of over 5% last month, has now dropped below 4.6%. This decrease is primarily driven by the expectation that the Federal Reserve has concluded its series of short-term interest rate increases. As a result, buyers have flocked in, causing the price of bonds to rise and their yields to fall.

There are compelling reasons to believe that these yields will continue to decrease. Currently, the bond’s yield is still more than 2 percentage points above the projected average annual inflation rate for the next decade. This discrepancy could attract investors seeking a combination of stocks and bonds as a hedge against the inherently risky nature of the stock market.

When bond yields decline, it is growth stocks in the technology sector that benefit the most. These companies rely heavily on future profits, which are often projected to occur several years in the future. Lower yields on long-dated bonds increase the value of these future profits. Consequently, valuations of these growth stocks rise, often depicted as multiples of expected per-share earnings in the upcoming year.

This inverse relationship between tech stock prices and bond yields demonstrates the crucial impact that yields have on stock prices. It explains why tech stocks faced difficulties during periods of rising yields and why they tend to thrive during periods of falling yields. This principle is referred to as negative correlation, and it plays a key role in investment strategies.

In summary, the current decline in bond yields presents an opportunity for growth stocks, particularly those in the technology sector, to flourish. Investors should consider this important relationship between bond yields and stock prices when making investment decisions.

Tech Stocks with Negative Correlation to 10-Year Yield

Several tech stocks are exhibiting a negative correlation to the 10-year yield, suggesting a potential inverse relationship between their performance and interest rates. (AMZN) has shown a negative 74.8% correlation over the past four years, according to 22V Research. This seems logical considering Amazon’s reputation as a high-growth stock. Analysts predict an annual increase of approximately 30% in earnings per share (EPS) for the next five years.

Another example is ServiceNow (NOW), which also exhibits a negative correlation of 79.5% to the 10-year yield. Analysts foresee over 20% annual EPS growth for the next three years. However, there are currently no published estimates on FactSet beyond 2026.

Not limited to tech, other notable companies that fit this description include Nvidia (NVDA), Microsoft (MSFT), and Advanced Micro Devices (AMD). These three not only show faster expected profit growth compared to the S&P 500 but also exhibit correlations of at least negative 60%.

Outside of the tech sector, other growth-oriented names demonstrate similar characteristics. Tesla (TSLA), Nike (NKE), Intuitive Surgical (ISRG), and Align Technology (ALGN) are among them.

The recent focus on Wall Street has revolved around bonds and their potential consequences for the stock market. This correlation between tech stocks and the 10-year yield provides food for thought and raises important considerations for investors.

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