“If you can keep your head when all about you
Are losing theirs and blaming it on you”*, (Rudyard Kipling)
‘Who’d be a bond? Not only do you probably have a negative real yield, but equity investors blame you for everything.’
‘My equity portfolio underperformed because of the bond market.’
‘Equities fell because yields rose.’
‘Equities fell because yields fell.’
Whilst equities gyrate, market watchers appear to either credit or blame rising or falling bond yields at an alarmingly contradictory rate. It is forgivable to be slightly confused when trying to understand whether bond market moves are good or bad for your portfolio of equities. Unfortunately, at Merrion Investment Managers we do not have the definitive answer (there isn’t one!) but we thought it would be helpful if we shared our investment framework with you on this.
In general, there is a historic positive relationship between periods of rising yields and equity performance. Yields tend to rise when economic growth is good, so it is understandable to see equities rise alongside a growing economy. The difficulty arises when we start to differentiate between what we mean by yields, and over what time frame are we talking about. If yields are rising in longer dated bonds, (think of that as the market rate) it is usually against a positive economic backdrop. If, however yields are rising in shorter dated bonds (policy rates) it can weigh on equities as it can be seen as a precursor to tighter monetary policy. We then need to look at from what level these moves are occurring. Are they happening quicker or slower than the market expected, and are we talking about real or nominal yields? Hence you can see why I said earlier that there is no definitive answer.
The speed of the move matters too. A gentle glide higher in yields is reflective of a steady economic and monetary backdrop, one in which equities can thrive. A sudden move higher however can be a signal of a shift in either the inflationary environment or a sudden change in central bank policy. A sudden drop lower can be a sign of a growth shock or a risk-off event that wasn’t expected. Equity investors can look to short-term moves in the bond market to ascertain whether they should be worried or excited about the latest news flow, seeing the bond market as a purer economic forecasting tool. Hence it is the bond market’s reaction to a certain event, confirming equity markets fears or hopes that is the reason for the move, not the actual bond market itself that can sometime matter.
In theory lower yields should help the valuation of equities but historically rising yields have actually been associated with rising valuation multiples for equities. The reaction within equity markets is not consistent either. This adds another layer of complication. Rising yields can help the earnings power of banks and insurance companies, hinder the valuation of technology companies, complement and confirm the performance of commodity stocks yet take away from the dividend appeal of staples!
There is no definitive answer on the impact of bond yields on equities and yet it is one of the most important factors in determining asset price performance. At Merrion Investment Managers we have a broad based three pillar investment process that allows us to capture this ambiguity where essentially all bonds count…“but none too much”*.
*If by Rudyard Kipling.
Philip Byrne is Deputy Chief Investment Officer, Head of Equity Investments at Merrion Investment Managers, a division of Cantor Fitzgerald Ireland.
Contact details for each individual team member can be accessed here on our website should you wish to speak with a Portfolio Manager or Account Executive.