Something’s happening in the bond market.

And it’s making people nervous.

The 30-year Treasury bond yield has climbed to its highest level. And if there’s one thing we don’t know today, it is where long-term interest rates are ultimately headed. You don’t know. I don’t know. Even Mr. Market doesn't know.

But what I know is this. When bond yields move like this, it’s a signal.

First - how do bond yields actually work?

You see, long-term bond yields - especially the 10-year and 30-year Treasury yields are driven by market forces. Unlike short-term interest rates that are directly influenced by central banks, long-term yields reflect what the market is thinking - inflation, economic growth, purchasing power and so on. When they buy bonds, yields fall. When they sell bonds, yields rise.

Today, the 30-year yield going up means investors are demanding higher yields before they are willing to lend to the government for the long-term.

So what’s driving rising 30-year bond yields?

First, geopolitics. The ongoing Middle East war has disrupted supply chains and pushed oil prices sharply higher. This has caused higher energy prices to ripple through transport, manufacturing, and energy bills. In other words, everything that moves or gets made costs more now - shipment and raw materials for example.

All this points to one thing - higher inflation.

Next, high inflation forces bond prices to drop. I’ll explain. Now, bonds pay a fixed income. If inflation is rising, the fixed coupons are worth less down the road. No rational investor wants to hang onto an asset that destroys their purchasing power. As a result, investors sell bonds, prices drop. Yield rises.

That’s why it’s rising more than 5% - even higher when I first started my career in an investment bank many years ago.

The biggest problem - growth stocks

The problem with higher long-term bond yields is this. When bond yields rise too high, high growth stocks usually get hit first. This is especially true for AI stocks, technology companies, and fast growing businesses trading at “rich valuations”. This is because this group of stocks valuations are priced based on their future profits that may only come five, ten or even 20 years away. In other words, many growth stocks are valued based on profits far into the future. This makes them very sensitive to changes in interest rates. When yields go up, those future earnings will get discounted heavily - causing valuations to compress.

This happened during 2022. When the Federal Reserve hiked interest rates aggressively, long-term yields went up, and the Nasdaq fell over 30% back then. The most speculative growth stocks were hammered 60-70% from their peaks. That’s why some of the tech giants we see. In fact, 35% of the S&P 500 accounts for technology, mostly in these handful of tech giants.

Second problem - debt. This is often overlooked. High growth companies normally rely on debt to fund their expansion. When long-term yield rises, borrowing costs go up. This squeezes profit margins, slows growth and forces these companies to slow down. What happens next? Valuation cycle changes.

But it’s not all bad news

As a former fixed income analyst, a 30-year yield above 5% also means it’s a return to a normalized yield environment. This is a good thing. Long-term bond yields are normally higher for short-term yields to compensate investors for the risk. It also could mean there’s economic growth, given the higher inflation.

How to accumulate profitably for dividends

If we can ride through this long-term yield rise, then it’s definitely worth investing for income.

High long term yields could hit interest rate sensitive sectors - property, REITs, infrastructure, telco, utilities and so on. However, what matters most is picking up high-quality dividend stocks during this time.

For instance, when interest rates went up in 2022-2023, I was actively picking up Singapore REITs back. I was picking up dividend stocks like China Mobile when it was trading at 9%, when no one was looking at it. Even utilities like Netlink Trust when it was trading ~6.5% yield.

Look, the best time to buy always starts when the market starts to get fearful for the wrong things.

Today, bond yields are sending a signal that’s making investors nervous. The two big problems that will get hit most are high valuations across growth stocks and leverage - both I’m real careful about.

What matters is whether we’re focused on our investing strategy for the long-term. Knowing what are the right stocks to pick for accumulating wealth as the market cycle changes. It just means I’m more prepared to take advantage of the opportunities that lie ahead.

Willie Keng, CFA

Founder, dividendtitan.com

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