Concern that a surge in U.S. bond yields will curb the expansion is overblown, says money manager James Paulsen. When coupled with gains in confidence, higher borrowing costs are a healthy sign for the world’s largest economy.
“Confidence is at the center of everything here,” said Paulsen, the chief investment strategist at Wells Capital Management in Minneapolis with $340 billion in assets under management. “If I had to pick one overriding thing, it’s confidence that’s been running through the financial markets and the economy this year.”
Since 1967, stocks have risen at a 12.8 percent annualized rate in months when bond yields and the Conference Board’s consumer confidence measure rise in tandem, according Paulsen’s research. When borrowing costs increase and confidence drops, stocks -- a proxy for investors’ views on the direction of the economy and corporate profits -- have fallen at a 6.4 percent rate.
Currently, consumers are the least pessimistic in more than five years, homebuilders are the most upbeat since 2005 and purchasing managers say their factories are churning out goods at the fastest pace in almost a decade. That improving economic outlook is one reason that Federal Reserve Chairman Ben S. Bernanke may opt to slow the monthly pace of $85 billion in bond purchases as soon as the Fed’s Sept. 17-18 meeting.
The yield on the benchmark 10-year Treasury note rose to 2.88 percent late yesterday, reaching two-year highs for a third consecutive day, as investors become increasingly convinced the Fed next month will reduce how much stimulus it pumps into the economy. The yield had been as low as 1.63 percent on May 2.
Yields on U.S. corporate bonds from the riskiest to most- creditworthy borrowers have climbed to 4.23 percent from a record-low 3.35 percent on May 2, according to the Bank of America Merrill Lynch U.S. Corporate & High Yield Index. They reached a one-year high of 4.3 percent on June 25.
So far this year, rising yields have been accompanied by improving confidence. The Bloomberg Consumer Comfort Index early this month reached the highest reading since January 2008. The New York-based Conference Board’s confidence gauge in June and July also had the strongest two months in more than five years. The Thomson Reuters/University of Michigan’s measure in July reached a six-year high, before falling this month.
“Consumers are so far saying, ‘OK, employment is improving, growth is improving, maybe not evenly, maybe not fast, but it is improving,’” said Adrian Miller, director of fixed-income strategy at GMP Securities LLC in New York. “The back-up in interest rates of late, dramatic as it may be from early May, is not yet at a level that would creep into the psyche of the consumer as being a problem.”