Notes on 5.3% US 10 Year Yields

There is a big difference between an equity investor seeing up and to the right on a chart and a bond investor seeing the same for bond yields. For the latter, it means a massive loss in bond value.

On 1st Oct’26, the 10-year US government bond hit ~5.3%, its highest level since the early 2000s. On the same day, the UK and French yields also hit multi-decade highs. The same story is playing out in Japan and other Eurozone countries. Among large economies, China is the main exception (its 10-year yield is at a 1-year low). Canada and India have seen smaller rises. Since October 1, yields have stayed near these highs.

Capitalism rests on the idea that rational, free actors choose what best serves their economic interests. Government bond yields are the benchmark every other asset’s return must compete with.

When the US government pays you ~5.3%, that is the opportunity cost every other asset must beat with a decent risk premium (for taking risk). Especially for equities, the discount rate is set directly using the risk-free (at least in theory) rate of government bonds.

Warren Buffett described interest rates as acting like gravity on asset prices, including equities.

The takeaway is simple: as rates go up, the equity market may get derated. This has not happened yet. The S&P 500 trades at ~27x trailing earnings, even though the 10-year yield has gone from ~1.5% in 2021 to ~5.3% today. But the risk cannot be ignored.

We spend much of this article on the key changes in our investment process.

5-6% yields are not new. The US 10-year yield was at or above 5% in almost every year from 1968 to 2002. What makes this time different is how indebted governments are worldwide (including the US government).

As governments are more indebted today than in the past 30 years, their fiscal capacity to spend is limited. Also, because they are so highly leveraged, interest payments on the debt will be much higher than in 2007/2000. This crowds out welfare spending and other priorities like defense.

A famous Buffett example has been that the Dow closed 1964 at ~870 and closed 1981 at ~875. In between, long-term bond yields went from just over 4% to more than 15%. Warren Buffett wrote in 1999 that interest rates ‘act on financial valuations the way gravity acts on matter’. History does not always repeat itself, but what I want you to take away is that a rising interest rate environment is not good for equities.

Read through our QGV framework posted in Sep’25. The key here is that our investment process stands on 3 pillars.

Quality matters most, followed by growth and, finally, valuation. All 3 are needed to make a successful investment. A quality business generates strong cash flow and funds its own growth, so it doesn't need to borrow at 6-8%. Growth helps offset a lower multiple. Value is the bedrock of any investment.

Buffett’s 1977 essay on inflation starts from a simple idea: ‘stocks, in economic substance, are really very similar to bonds.’ The question is how much a business’s earnings are worth when a government bond pays 5-6% with no risk.

The answer depends on how far away the cash flows are. In the table below, you demand the risk-free rate plus a 4% equity premium, and the business earns 15% on its reinvested capital.

The same move in rates takes ~30% off a business that does not grow and about half off a fast grower. Growth is still valuable, but only if you do not overpay for it.

But higher rates don't guarantee value wins. AQR’s study of value returns from 1954 to 2019 concluded that “the interest rate regime offers little insight into value’s prospects”. In September, semiconductor stocks rose ~9% while utilities, staples and real estate fell 5-7%.

Despite the math, in my estimate, in a higher-interest-rate environment, you don't want to chase low-growth, free-cash-flow machines unless they are available at a cheap valuation (as close to no growth as possible).

The longer-term secular reasons for yields going up are:

The immediate reason for bond yields rising is the war in the Middle East, which has driven up energy costs. This has directly increased inflation expectations, pushing yields higher.

The immediate bond turmoil will resolve itself sooner or later and lead to a short-term decline in yields. But unless the long-run secular dynamics of excessive government debt borrowing are resolved, we will remain in a higher-for-longer market.

I don’t expect yields to return to the near-zero levels the market got used to over the next 5-10 years, at least outside an economic crisis. They may settle at 4% or 6%, but in both cases, equity assets will derate compared to the zero-interest-rate environment we came out of over the last 5-10 years.