Do rising bond yields impact equity markets?

30th April 2018
-Performance, IAM

Erika Mesmer, Client Relationship Manager

In the last few months we have seen bond yields rise significantly. In the US, the 10 year treasury reached 3%, having risen from a low of 1.35% in July 2016. In Switzerland the picture is similar: the 10 year bonds of the Swiss Confederation rose over the same period from -0.70% to nudging the +0.20%. Although the evolution of the rates in the short term will continue to show many ups and downs, we believe that we are at a turning point in long term trends. Since the 1980s we have seen interest rates come down, to reach very low and even negative territory. Going forward we’ll see rates climb in the years to come.

The beginning of the year has seen both rising rates and sell offs in equity markets, which has led some commentators to link the two events together – rising bond rates must impact share prices negatively. But is this true?

In the Financial Times of April 11th, 2018, Stuart Kirk published a very interesting article, explaining that there is no link between bond yields and dividend yields (“Relationship between bond and dividend yields has no grounds”). In short, he highlighted both theoretical evidences of this claim, and more interestingly, how dividend yields and bond yields have moved over different decades: looking at the period closest to our mind, from 2000 onwards, the two moved in opposite directions, bond yields down and dividend yields up. Looking further back to the 80s and 90s, their direction was the same – downwards. Prior to that in the 1970s the direction of both was also the same, however at that time upwards. And, in order to complete the picture, in the 50s and 60s, you might have guessed, the directions were opposite, with raising bond yields and falling dividend yields.

Although there is no direct relationship between bond yields and dividend yields, this does not mean that equity markets will not be impacted by rising bond yields in the future. Over the last decade central banks have flooded the market with liquidity and the cost of financing projects has never been as low. This has allowed many companies to benefit from this very friendly environment. Going forward, when cost of capital will become more expensive due to rising interest rates, we will see companies of lesser quality struggle, while financially strong companies will continue to perform well. Especially companies with regular and strong income streams will be able to continue to build their business and invest in their future without suffering from higher interest rates