The stock market has climbed to impressive heights, but one of Wall Street’s best-known bulls is becoming more cautious.
Ed Yardeni, president of Yardeni Research, recently lowered his year-end target for the S&P 500 to 7,900 from 8,400. Based on Tuesday’s closing level of 7,585.73, his revised forecast suggests the index could gain another 4.1% before the end of the year.
That is still a positive outlook. However, it is considerably less optimistic than Yardeni’s previous target, which suggested the S&P 500 could rise another 11%. The reason for his growing caution is fairly straightforward: Bond yields, oil prices and inflation are all moving in the wrong direction for the stock market.
Bond Yields Are Sending a Warning
The yield on the benchmark 10-year Treasury note climbed as high as 5.041% this week. That is a level investors have not seen since 2007. While higher yields may sound like good news for savers, they can create several problems for stocks.
For one, bonds become more attractive when they offer investors yields of around 5%. Investors can earn a relatively strong return from government debt without accepting the volatility that comes with owning stocks.
Higher yields also increase borrowing costs throughout the economy. Mortgages, auto loans, business loans and corporate debt can all become more expensive. That can slow consumer spending, reduce business investment and put pressure on economic growth.
Yardeni believes these conditions have increased the possibility of an economic slowdown over the next three to six months.
How to Invest When Bond Yields Are High
When bond yields rise, fixed-income investments become more attractive relative to stocks, leading some investors to rotate from stocks into bonds. However, there are still some high-yield dividend stocks that can offer investors a total return that outpaces bonds. One example is Altria (NYSE: MO), which combines a 6.03% dividend yield with defensive positioning.
Oil Above $100 Adds to the Pressure
Bond yields are not the market’s only concern. Oil prices have risen sharply as the war in the Middle East continues. Both Brent crude and U.S. crude have gained more than 20% over the past month, pushing their prices above $100 per barrel.
That matters because energy affects nearly every corner of the economy. Higher oil prices can increase the cost of gasoline, air travel, shipping, manufacturing and agriculture. Businesses facing higher expenses may attempt to pass those costs along to consumers, adding another layer of inflation.
Consumers may also pull back on discretionary spending when more of their income is needed to fill their gas tanks, pay utility bills or cover higher prices at the grocery store. In other words, expensive oil can slow economic growth while simultaneously keeping inflation elevated. That is an uncomfortable combination for the Federal Reserve—and for investors.
How to Invest For Higher Oil Prices
Investors are truly spoiled for choice in the energy sector. There are several stocks that are outperforming the S&P 500. Investors can keep it simple by investing in integrated oil companies like ExxonMobil (NYSE: XOM) or Chevron (NYSE: CVX).
This can also be a good time to look at refiners such as Valero (NYSE: VLO) or pipeline companies like Kinder Morgan (NYSE: KMI). Each of these stocks is outperforming the S&P 500 and pay a generous dividend.
All Eyes Are on the Federal Reserve
Recent inflation reports have been hotter than expected, increasing pressure on the Federal Reserve to raise interest rates. Investors are widely expecting the central bank to announce a quarter-percentage-point rate increase. Such a move would bring the federal funds rate to a range of 3.75% to 4%. The CME Group’s FedWatch tool recently showed a 93% probability.
With that, and despite lowering his near-term S&P 500 target, Yardeni has not abandoned his long-term bullish outlook. He continues to believe the S&P 500 can reach 10,000 by the end of the decade. That would represent a gain of approximately 32% from current levels.
His message is not that investors should panic or sell everything. Instead, it is a reminder that the market could face more turbulence before resuming its longer-term advance. With oil above $100, the 10-year Treasury yield around 5% and inflation remaining stubborn, stocks may have a harder time climbing in a straight line. Corporate earnings could remain healthy, but investors may become less willing to pay premium valuations while borrowing costs are elevated.
For long-term investors, periods of volatility can still create attractive opportunities. The key is to remain selective, avoid chasing overheated stocks and maintain enough liquidity to take advantage of meaningful pullbacks.
The market’s long-term direction may still be higher. Over the next several months, however, investors may want to follow Yardeni’s advice: Proceed with caution.
