Morgan Stanley weighs in on correlation between stocks and yields

Investing.com – A negative correlation between stocks and US government bond yields is likely to persist until the 10-year Treasury yield falls back below the 4.50% level, according to analysts at Morgan Stanley (NYSE:MS).

After retreating from multi-month highs last week following softer-than-anticipated core inflation data, the benchmark 10-year yield edged higher on Friday in response to separate figures showing solid US manufacturing output and single-family homebuilding.

The numbers, along with ongoing uncertainty surrounding the possible impact of President-elect Donald Trump’s policy plans, helped to maintain expectations that the Federal Reserve may slowly roll out potential interest rate reductions this year.

Although equities have remained somewhat buoyed by hopes that Trump’s return to office will usher in an era of looser regulations and corporate tax cuts, recently elevated bond yields have threatened the attractiveness of stocks.

“Index direction will be primarily determined by the level and direction” of longer-dated yields and the term premium, or the excess return investors demand for holding back-dated bonds instead of shorter-term debt, the Morgan Stanley analysts led by Michael Wilson said in a note to clients.

A “negative correlation” between bonds and stocks is tipped to persist until the 10-year yield drops “below 4.50% and/or the term premium declines on a sustainable basis”, they added.

The analysts said, in the current trading environment, they prefer “higher-quality stocks across industries showing relative earnings revisions momentum”, particularly financials, media and entertainment, and consumer services over consumer goods.