Don’t worry about rates until the 10-year yield nears 4%

Yields have been rising as investors fear that inflationary pressures in the U.S. will lead the Federal Reserve to tighten monetary policy at a faster pace than expected. The 10-year yield hit 3.11 percent last week — its highest level since 2011 — while the two-year yield hovered around a near-decade high.

“The actual impact of interest rate changes on equity prices depends on the reason interest rates are rising. If interest rates rise in anticipation of faster economic activity, this could lift growth expectations and also lower the equity risk premium,” noted Kostin.

The 10-year yield had risen about 71 basis points year to date through Friday, Kostin points out. Stocks, however, have weathered the sharp rise in yields thus far. Entering Monday’s session, the S&P 500 and Nasdaq composite were up 1.5 percent and 6.5 percent for the year, respectively, while the Dow Jones industrial average is flat. The small-caps Russell 2000, meanwhile, hit an all-time intraday high Monday and is up 6,6 percent in 2018.

“Assuming no valuation change, strong earnings and dividend growth will lift the S&P 500 index to our year-end 2018 target of 2850,” said Kostin.

The strategist added he recommended investors overweight the financials sector, which benefits from rising interest rates. Financials highlighted by Kostin include Bank of America, Wells Fargo, State Street and Capital One Financial.