Bond yields have become one of the main forces shaping U.S. stocks this month. According to Penn Mutual Asset Management, the 10-year Treasury yield closed on October 5 at its highest level since 2002 and finished that week at 5.24%. For equity investors, the move is a reminder that stock prices do not exist in isolation from the cost of money.

What the Auctions Showed

Treasury auctions are a direct read on what investors demand to lend to the government. Penn Mutual reported that the 10-year auction cleared at 5.30% around October 7, the highest auction yield since 2000, and that the 30-year auction cleared at 5.62%. Both drew solid demand, including from foreign and institutional buyers.

The firm noted that auction yields were roughly 30 to 50 basis points above early-September levels. It also pointed to weak demand for five-year notes in late September, when Treasury had to pay up to sell the debt; the source reports that auction cleared at 5.033%. The takeaway from the strong long-end auctions, in the firm’s reading, is that investors appear more willing to lend to the government at these higher yields.

Why Yields Matter to Stocks

There are three main channels through which higher Treasury yields can weigh on equities.

  • Discounting future profits: A stock is worth the present value of the earnings it is expected to produce. A higher yield raises the rate used to discount those earnings, which lowers the value placed on profits far in the future. Growth companies, whose earnings are weighted toward later years, tend to be most sensitive.
  • Competition from bonds: When a 10-year Treasury pays above 5%, the extra return that stocks must offer to justify their risk looks larger. Some investors may shift money toward fixed income.
  • Borrowing costs: Higher yields tend to feed through to corporate borrowing rates, mortgage rates and consumer credit, which can squeeze margins and demand over time.

These effects do not operate mechanically. If yields rise because the economy is strong and profits are growing, stocks can absorb the move. The concern is greater when yields rise because of inflation worries or heavy government borrowing.

Fed Expectations in the Background

The Federal Reserve is part of the story. Penn Mutual noted that September payrolls rose by 29,000, well below expectations, and that markets responded by pushing back the expected timing of the next rate hike from October to December. The firm also said the minutes of the September Federal Open Market Committee meeting showed most officials expect another rate increase by the end of the year.

Short-term rates are set by the Fed, but longer-term yields reflect expectations for inflation, growth and Treasury supply. That is why the 10-year can climb even when the labor market shows signs of cooling.

How Stocks Have Held Up

Equities have shown resilience despite the bond selloff. Penn Mutual reported that the S&P 500 gained 1.15% during the week of October 5 to 9 and finished just short of a record. Individual shocks have still been felt. On October 8, a report that OpenAI’s revenue was below expectations pushed chip stocks down more than 3%. On October 9, news that SpaceX had agreed to buy a nationwide spectrum portfolio for its Starlink Mobile service sent T-Mobile, AT&T and Verizon shares down 10% to 13%, while tower owners rallied.

Those episodes show that company-specific news is still moving prices sharply, even as the macro backdrop shifts underneath.

Earnings as a Counterweight

Strong profit growth is one reason stocks have not yielded more to higher rates. FactSet’s third-quarter preview put expected S&P 500 earnings growth at 29.5% and the forward price-to-earnings ratio at 19.0, below its five-year average of 19.8. Rapid earnings growth can offset some of the valuation pressure from higher yields, though it must keep delivering for that to hold.

What Investors Are Watching

  • Long-end demand: Further Treasury auctions will show whether buyers keep stepping in at current yields. Penn Mutual noted that 20-year bond and five-year TIPS auctions were scheduled for the following week.
  • Inflation data: Penn Mutual said the September consumer price index was due October 14, with headline inflation expected to rise to 3.6%.
  • Fed signals: Commentary from Fed officials, including Chair Kevin Warsh, will be parsed for clues on the path of rates.
  • Earnings quality: Whether companies can sustain double-digit profit growth as financing costs rise.

The relationship between yields and stocks is not fixed. Over short periods, a sharp rise in yields often coincides with weaker equity multiples, while over longer periods the drivers of earnings tend to dominate. With the 10-year near levels last seen more than two decades ago, the interaction is likely to remain a central market theme into year-end.

This article is for informational purposes only and is not investment advice.

Sources: Penn Mutual Asset Management; FactSet Insight.