Bonds Bite Back

Is this really the beginning of end, and what does it mean for financial markets?

Rising bond yields have hit equity markets over the last week. We look ahead and ask whether this trend signals the end of the bull market.

There is also a lot going on with respect to the virus, vaccines and lockdowns, not to mention corporate earnings. We’ll discuss all these in more detail in our monthly webinar on Thursday – so don’t forget to register.

Positive on economic activity but fearful of inflation worries

Regular readers of these updates will know that we’ve been optimistic about recovery in economic activity and corporate earnings – good news for equities – but also worried about fears of inflation that would push up bond yields – bad news for equities. Bond yields have certainly gone up but last week was different: real yields also rose. By over 20 basis points for 10-year TIPS – the US equivalent of our indexed-linked gilts. That’s a big move. Even as yields on conventional Treasuries rose strongly after the vaccine news broke last autumn, real yields stayed low, beyond minus 1% for 10-year maturities in the US. They have now broken through to -0.8%.

Growth stocks and gold could suffer

Low, indeed negative, real yields are a big support for risk assets. They also favour stocks that have their earnings in the distant future – growth stocks and gold. We could see these assets suffer if real yields continue to rise.

But when it comes to the more general question of whether rising yields threaten the broader market, we can be more positive. Remember that all this is happening because markets realise that the astonishing power of the vaccines means that the global economy can get back to something like normal during the course of this year. When yields rise because growth is getting better, that’s typically positive for risk assets. And economic policy is highly supportive. Be it central banks keeping official rates ultra low, quantitative easing or fiscal policy.

The outlook for profits is positive

There are other positives too: inflows to equities are strong – this is the normal pattern at this stage of the economic recovery. That’s a lot of demand for equities. It’s not the upturn in yields that typically signals the end of a bull market in equities, rather the downturn in growth. And growth is heading up, which is a big positive. Corporate buybacks in the US have also been very strong, in line with the much stronger-than-expected earnings season – and of course, buybacks were suppressed last year by the pandemic. The outlook for profits is very positive indeed, in my opinion.