Active investors and money managers continually ask one question: How much reward am I taking on for the risk? That question becomes deafeningly loud at inflection points, when the masses are too long or short, and the risk of a reversal climbs.
Right now, we may not be at the deafening stage, but the risk/reward matrix is definitely getting louder as yields on the arbiter of risk-free returns, the 10-year Treasury Bond, have surged to 4.92%, its highest since October 2023.
The yield jump then coincided with a major S&P 500 bottom, but this time around, the backdrop is different.
At the 2023 lows, there were still many stock market doubters on the sidelines because we were only about a year removed from the brutal 2022 bear market, and the S&P 500 ETF (SPY) had retreated 3.6% from its springtime high.
Today, the S&P 500 is near all-time highs and four years into double-digit returns, following a 4% gain since its July Iran-War-driven lows, driven by insatiable gains and economic growth associated with trillions of dollars flowing into artificial intelligence.
Treasury Bond yields become particularly tasty versus stocks
When you feel relatively confident that the stock market can deliver double-digit gains, you’re more likely to pass on buying bonds that yield 4% or less, like the 10-year yield was in February.
Now that the S&P 500 is up 11% year-to-date, and most Wall Street analysts’ forecasts for the index show mid-digit returns into year-end as of August, investors are likely more willing to trade their high-flyers for higher yields, especially if the 10-year cracks above the psychological 5% barrier, breaking out to new highs.
The tilt toward bonds is arguably strengthened by elevated valuation metrics. The S&P 500’s forward P/E ratio is 19.5, according to FactSet; not terrible, but not necessarily a bargain.
The ratio has been helped significantly by earnings expansion associated with knock on effects of surging AI spending supporting GDP growth. Still real GDP (adjusted for inflation) is expanding more slowly than 2025, rising 1.5% in the second quarter, down from 3.8% in Q2, 2025.
The Shiller Cyclically Adjusted PE (CAPE) ratio is worse, at roughly 40.7, about 45% higher than its 20-year average.
So, yes, growth is growth, but historically, sustaining growth becomes harder when borrowing rates rise, and lending rates are influenced by the 10-year Treasury yield.
That suggests higher yields may drag down borrowing and spending, taxing real GDP, slowing earnings growth, and potentially pressuring P/E ratios unless stocks pullback to account for the risk.
Popular economist Mohamed A. El-Erian summed it up nicely.
“If these moves and levels persist, let alone get worse, they will ring alarm bells across most economies as they: Intensify affordability pressures, Fuel headwinds to growth, Worsen inequality, Weaken fiscal dynamics, and Add to financial instability risks,” wrote El-Erian recently on X.
Mid-Term Elections throw stock market a curveball
Worries that mid-term elections could shift policies in D.C. tend to make mid-term election years challenging for the S&P 500. So far, stocks have largely brushed off election risks, but September is a troublesome month historically for the markets.
Historically, September ranks as the 12th worst month for average gains. And that’s not just for the S&P 500. It’s also the worst month for the Dow Jones Industrial Average, Nasdaq, Russell 2000, and Russell 3000, according to the Stock Trader’s Alamanc.
So, yeah, not good, historically. Couple September doldrums with the fact that mid-term election years are the worst performing years, on average, for the S&P 500 in the four year Presidential cycle, and you can’t really blame investors for at least considering bonds yielding at 5%.
A market word of caution, and a dose of reality
Stocks fall faster than they climb, and 3% to 5% drops are incredibly common. A dip of 3% happens nearly four times per year, and 5% declines happen about once a year. Investors who react to sharply to the risk of short-term dips often leave money on the table once the selling ends and markets rally back.
Stocks also don’t rise or fall in a straight line. It wouldn’t be shocking to see bond buyers step in with yields here, causing a relief rally, at least short term.
The key therefore is to plan rather than panic. Check your holdings. Are you comfortable with them?
Check your portfolio sizing? Are you comfortable with your exposure to any single investment?
If not, consider trimming a little. Worst case, you park the money in money markets, which are yielding 3% to 4%, while you let the dust settle. Best case, that money gives you dry powder to buy some stocks on your watch list at more favorable prices over the coming weeks.
