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Why I think share prices could drop in May

It’s a coincidence that the 10-year US government bond yield broke above the psychologically important 3% mark just as we head into the new month, which is regarded as “Friday the 13th” by equity investors.

The rising yield on the US government bond (called Treasury) is making share investors around the world nervous and could be the trigger for those looking for an excuse to fulfil one of the best-known market adages – “sell in May, go away”.

There’s a fairly unanimous consensus among experts that the 10-year Treasury yield is heading higher in the short-term now that it’s finally broken through 3% to trade at 3.03% this morning. The yield on this sovereign bond has added 69 basis points over the past year.

May has historically been a month of poor returns for the S&P/ASX 200 (Index:^AXJO) (ASX:XJO) and the weakness tends to stick around through June.

Those hoping that we might skip the seasonal weakness this after the brutal beating the market received in March are likely to get their faith tested as I believe there are more reasons for ASX stocks to retreat than move forward over the next month or two.

Higher yields are one concern as they mean lower valuations for stocks. Analysts typically use the 10-year government bond as the reference rate to discount future cash flows from a listed company. The higher the bond yield, the lower the target price of the stock.

There are also fears that rising yields, and cost of debt, will crimp economic growth. Experts are still debating on what that level is, and until there is greater clarity, investors may be tempted to sell now and ask questions later.

This is bad news for our big banks which include Commonwealth Bank of Australia (ASX: CBA), Westpac Banking Corp (ASX: WBC), National Australia Bank Ltd. (ASX: NAB) and Australia and New Zealand Banking Group (ASX: ANZ).

The big four are already under pressure from the Banking Royal Commission and a slowing housing market. Rising yields will be another headwind for the sector.

Other ASX 200 index heavyweights will also likely come under pressure. This includes our big miners like BHP Billiton Limited (ASX: BHP) and Rio Tinto Limited (ASX: RIO) even though their fortunes will be closely tied to volatile commodity markets.

It’s hard to see how blue-chips like blood products maker CSL Limited (ASX: CSL), investment bank Macquarie Group Ltd (ASX: MQG), global packing giant Amcor Limited (ASX: AMC) and logistics group Brambles Limited (ASX: BXB) can outperform when the top 200 index is under pressure, but they can at least benefit from the falling Australian dollar that I think is at risk of falling further this year.

But any impending market weakness is a good opportunity for investors to pick up more quality blue-chip stocks as equities are still well placed to generate good returns in 2018.

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Motley Fool contributor Brendon Lau owns shares of Australia & New Zealand Banking Group Limited, BHP Billiton Limited, Brambles Limited, Macquarie Group Limited, National Australia Bank Limited, Rio Tinto Ltd., and Westpac Banking. The Motley Fool Australia owns shares of National Australia Bank Limited. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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