If the Bond Market Sell-Off Triggers a Recession, Decades of History Says Investors Should Do This 1 Thing

One of the biggest trends that stock market investors are watching right now is something that might seem unrelated to stocks: bond prices and bond yields. The bond market is going through interesting times. Maybe not in a "good" way.

In the past few months, global bond yields have surged. The widely watched yield on the 10-year U.S. Treasury bond has climbed from about 4.03% one year ago to about 5.24% as of Oct. 11. The 10-year yield is reaching some of its highest levels since 2002. This is what's known as a bond market sell-off. Bond investors are refusing to buy bonds unless they get paid a higher yield for their money.

10 Year Treasury Rate data by YCharts

Do higher bond yields mean a recession is coming? Will high bond yields cause a stock market crash? The answer to both questions is: not necessarily. It's important to be cautious about bond yields, but not to over-react. Long-term stock market investors have many reasons to be hopeful -- and stay the course.

Let's look at what higher bond yields might mean for the stock market -- and what investors should do now.

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What higher bond yields mean for the economy and stocks

Higher bond yields mean higher interest rates on debt. Consumers and businesses have to pay more to borrow money. Fewer people and businesses take out new loans. Less new money gets created by banks by issuing loans, and less money flows into the economy as a result.

When bond yields go up, that can sometimes bring bad news for the stock market. Higher bond yields can be a warning sign of financial crises. When bond yields spike, this might mean that global bond investors are worried about high levels of national debt, and are acting as "bond vigilantes" who crack down on government borrowing. Higher bond yields can be a way of the bond market lowering the "credit score" of governments.

Much of the recent spike in bond yields has happened during a big rise in U.S. government borrowing since the 2020 pandemic. U.S. national debt recently passed $40 trillion. Here's what has happened to the 10-year Treasury bond yield as our national debt has risen since 2002:

10 Year Treasury Rate data by YCharts

Can higher bond yields cause recessions?

When bond yields go up fast enough, they can even tip the economy into recession. That's because when borrowing costs get too expensive too fast, parts of the economy start to break down. Some businesses and industries are more vulnerable than others to rising bond yields.

For example, the homebuilding industry typically gets hit hard by rising 10-year Treasury yields, because that Treasury rate is important for setting mortgage rates. More expensive debt makes homes harder to afford. Automakers and car dealers might also suffer from higher bond yields, as consumers find it harder to afford auto loans. Some businesses might struggle to refinance their debt or fail to repay their debts at higher interest rates.

These are just a few ways that rising bond yields can contribute to business failures, bankruptcies, job losses, and a slowing economy. None of these are good for stock prices.

How to invest in stocks during higher bond yields

Will the current rise in bond yields lead to a recession in 2027? Not necessarily. There are many reasons to be optimistic that today's economy is strong enough to keep growing, despite higher bond yields. And even if the economy slows down, it's important to take a longer-term perspective.

Here's what has happened to bond yields, the S&P 500 index (SNPINDEX: ^GSPC), and the U.S. economy in the past 50 years. The long-term trend has been for bond yields to come down, the S&P 500 to go up, and the U.S. economy to grow -- with a GDP of over $32 trillion. As shown in the chart below, today's 10-year Treasury yield of 5.22% is still 56 basis points lower than its 50-year long-term average.

^SPX data by YCharts

Today's slightly higher bond yields are worth keeping an eye on. They might even be a good reason to buy bonds. But none of this is reason to panic. The S&P 500 could still have room to grow. And history shows that the S&P 500 has bounced back from every recession, crisis and crash.

Keep in mind that during the past 98 years since 1928, the S&P 500 has delivered average annual returns of 9.98% through good times and bad, high interest rates and global crises. The Vanguard S&P 500 ETF (NYSEMKT: VOO) might be a good buy today, whether or not a recession is coming. VOO has delivered annualized returns of 13.75% (by net asset value) for the past five years, even with a negative -18.15% total return during the bear market of 2022.

There's no guarantee that a recession is coming, or that the bull market will continue. Either one could happen in 2027. But even if a downturn is around the corner, history says staying invested through recessions and expansions, ups and downs, is key to building long-term wealth.

Ben Gran has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Vanguard S&P 500 ETF. The Motley Fool has a disclosure policy.