Special Topic: Will a rising U.S. 10-year Treasury yield be the needle that pops the stock market bubble?

(I’ve been honing my clickbait skills. I don’t think we’re in a bubble, but stocks are trading at a high multiple and there are signs of speculative excess, also known as “froth.”)

Our Asset Allocation Committee (AAC) is positioned for the U.S. 10-year Treasury yield to rise. In bond parlance, we are short duration. Inflationary uncertainty, a flat yield curve, pro-growth policies, and significant deficits point in that direction.

This note explains how to manage interest rate risk across asset classes. I evaluate the sensitivity of asset class—pairs—to changes in the 10-year yield. There’s a nuanced relationship between asset classes and interest rates.

Given their negative duration and median relative valuation, floating rate loans present a compelling opportunity to capitalize on rising rates. Long-duration bonds are also an effective tool for duration management.

Estimating durations

We estimate the empirical duration of asset class pairs used for tactical asset allocation, such as value versus growth stocks, as follows:

Value? – Growth? = α + -Duration x Δ10y?

Several of my readers replicate our models. If you’re a quant who cares about the length of half-lives in exponential regressions (I do!), the information is below. But if you just want our conclusions, please skip over the next paragraph.

Methodology

Duration is the beta estimated from an exponentially weighted regression with a six-month half-life (expanding data window),1 following the structure of the above equation. We use rolling five-day cumulative returns on the left and the rolling five-day change in the 10-year yield on the right.2 Our data start on 1/8/2010 and end on 2/7/2025. We ran another version of this analysis controlling for equity beta, and the results were similar (not reported here).

The chart below shows the current duration (green bars) and historical range (blue lines) for 15 asset class pairs. A positive number means that the asset class on the left tends to underperform the one on the right when the 10-year yield goes up, and vice versa for a negative number.

Starting from the left, the duration of Treasury Long vs. U.S. Agg. (core investment grade) is 8. This means that when the 10-year yield increases by, say, +0.1%, Treasury Long underperforms U.S. Agg. Bonds on average by -0.8%.

Also, the taller the blue line, the wider the historical range and—generally—the noisier the estimate.

The duration of the stocks versus bonds pair—the last one on the right—is notoriously unstable. It’s currently -1.5 but has been as negative as -15 over our 1/8/2010 – 2/7/2025 period. A negative duration means that historically stocks have outperformed bonds when the 10-year yield increases. This tends to happen because rates often rise together with growth expectations (on the flipside, rates tend to come down and bonds rally when stocks sell off due to the flight-to-safety effect).

However, the negative duration is a historic average. It doesn’t always happen. Higher rates can hurt stocks even more than bonds, especially when stock valuations are high, and there’s an inflation (rather than growth) shock—hence my needle comment in the introduction. Many research articles have been written on the instability of the stock-bond correlation.3

Currently, the duration of U.S. growth vs. value is negative, which means Growth has been outperforming with rising rates. But this is an anomaly by historical standards, most likely due to the artificial intelligence theme. In theory, the cash flows of growth companies are further out in the future, which means a longer duration. Plus, value often outperforms with higher rates as financials boost their net interest margins and materials and commodities companies tend to benefit from rising inflation.

Bond market duration estimates are more reliable, as evidenced by the shorter blue bars for bond asset class pairs. Right now, the most interesting duration number is for floating rate versus U.S. aggregate. It has the most negative duration of all the pairs and shows a narrow historical range. This suggests that overweighting floating rate loans could be an efficient and precise way to benefit from rising rates.

Moreover, while spreads are generally tight across credit markets, floating rate trades at a median valuation relative to the U.S. aggregate. It has been out of favor due to expectations of Fed rate cuts. However, the current trend is toward fewer rather than more cuts as inflation rears its ugly head again.

The chart below maps relative valuation percentiles against empirical durations for asset class pairs. Two trades appear reasonably priced and offer efficient duration management: Floating Rate vs. U.S. Agg. and Treasury Long vs. U.S. Agg, (here, you would reduce the allocation to Treasury Long).

Of course, you could also consider a move from Treasury Long to Floating Rates to help reduce duration even more efficiently.

And if you think rates are coming down, reverse these trades.

Thank you to Berg Cui for running this analysis and to Cesare Buiatti, Josh Yocum, Rob Panariello, and Charles Shriver for their valuable contributions.

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REFERENCES

1 In other words, we give higher weight to the more recent data and place less value on older historical data.

2 We do this to maximize the number of data points while reducing the noise in daily data (which includes time zone issues and day-to-day news flow idiosyncrasies).

3 See, for example, Naik et al., “The stock-bond correlation,” Journal of Investment Strategies, Vol 4., Number 1, December 2014.

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DEFINITIONS

Empirical duration is the sensitivity of the asset’s return to changes in the 10-year bond yield.

Exponentially weighted regression is a formula applied in regression analysis which assumes recent data has greater importance than older historic data.

Forward Earnings Yield is the expected earnings per share (EPS) over the next 12 months divided by the current share price.

Regression models describe the relationship between measurable variables. At a basic level, a regression model allows for estimating how one variable is expected to change as another independent variable changes. The models can also help identify if it’s a strong or weak relationship between the two.

Relative Valuation is the concept of comparing the price of an asset to the market value of similar assets.

Yield to Worst?is the lowest possible yield an investor can receive from a bond assuming the issuer does not default.

For additional definitions of terms, please see: https://www.troweprice.com/glossary

In the figures, the names refer to the indices as follows:

Treasury Long—Barclays US Treasury Long Index

Bonds—Bloomberg Barclays U.S. Aggregate Index

Intl. Growth—MSCI EAFE Growth Index

Intl. Value—MSCI EAFE Value Index

U.S. Growth —Russell 1000 Growth Index

U.S. Value—Russell 1000 Value Index

RAF—Real Assets Combined Index Portfolio

EQ (Equity), Stocks—a mix of 70% Russell 3000 Index, 30% MSCI ACWI ex-US

EMD (Emerging Market Debt)— J.P. Morgan Emerging Market Bond Index Global Index

EMB (Emerging Market Bonds) — J.P. Morgan Emerging Market Bond Index Global Index

HY (High Yield)—Credit Suisse High Yield Index

U.S. Floating Rate—Morningstar LSTA Performing Loan Index

EM (Emerging Markets) Equity—MSCI Emerging Markets Index

U.S. SC (Small-Cap)— Russell 2000 Index

U.S. LC (Large-Cap) S&P 500

Intl. Bond Hedged—Bloomberg Barclays Global Aggregated Ex-US Index (USD Hedged)

Please see vendor indices disclaimers for more information about the sourcing information: www.troweprice.com/marketdata

IMPORTANT INFORMATION

The views contained herein are those of the author as of March 2025 and are subject to change without notice; these views may differ from those of other T. Rowe Price companies and/or associates.

This information is for informational purposes only and is not intended to reflect a current or past recommendation concerning investments, investment strategies, or account types; advice of any kind; or a solicitation of an offer to buy or sell any securities or investment services. The opinions and commentary provided do not consider the investment objectives or financial situation of any particular investor or class of investor. Please consider your own circumstances before making an investment decision.

Past performance is no guarantee of future results. All investments are subject to market risk, including the possible loss of principal. It is not possible to invest directly in an index. Diversification cannot assure a profit or protect against loss in a declining market. Stock prices can fall because of weakness in the broad market, a particular industry, or specific holdings. The value approach to investing carries the risk that the market will not recognize a security’s intrinsic value for a long time or that a stock judged to be undervalued may actually be appropriately priced. Growth stocks are subject to the volatility inherent in common stock investing, and their share price may fluctuate more than that of income?oriented stocks. Bonds may decline in response to rising interest rates, a credit rating downgrade or failure of the issue to make timely payments of interest or principal. Investments in high-yield bonds involve greater risk of price volatility, illiquidity, and default than higher-rated debt securities. Investments in bank loans (floating rate loans) may at times become difficult to value and highly illiquid; they are subject to credit risk such as nonpayment of principal or interest and risks of bankruptcy and insolvency.

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