By Lewis Krauskopf
NEW YORK (Reuters) - U.S. stocks have climbed this year despite rising Treasury yields, but equities could become more sensitive if yields push higher from current levels, Morgan Stanley strategists said on Monday.
Rising yields tend to pressure equity valuations, but this year "multiples have remained elevated in the face of rising rates," the Morgan Stanley equity strategists led by Michael Wilson said in a note.
But the strategists said 4.35% for the 10-year U.S. Treasury yield was "an important level to watch for signs that stocks' rate sensitivity may increase." The 10-year yield was last at 4.32% on Monday morning.
The bond market could become more volatile over the next few days, with policy decisions by the Federal Reserve and Bank of Japan.
"We think a key question for this week is whether the direction of rates will begin to matter more for the valuations of large cap equities," the Morgan Stanley strategists said.
The S&P 500's forward price-to-earnings ratio - a commonly used valuation metric - last stood at 20.5, near its highest level in about two years, according to LSEG Datastream. The benchmark index is up more than 8% so far in 2024.
Higher yields increase the attractiveness of owning "risk-free" Treasuries for investors. That in turn can dull the luster of riskier equity cash flows and tends to pressure stock valuations.
Small-cap stocks have been more negatively correlated to yields than large caps, "indicating small caps are likely to exhibit greater interest rate sensitivity than large caps on a move higher in rates," the Morgan Stanley strategists said.
The strategists were also watching to see if the 10-year yield falls below its 200-day moving average, which was about 4.195%.
"Should rates decisively fall back below the 200-day moving average, it could serve as support for equity valuations to remain elevated," Morgan Stanley wrote.