What Do Rising Bond Yields Mean For The US Stock Market?
Sean Markowitcz (Schroders) | Investors are fearful that higher yields will hurt equity valuations. But this does not mean equity returns have to suffer. Recently the Federal Reserve upgraded its forecast for US inflation and brought forward its timeline for raising interest rates. Although bond yields have fallen recently, they are still considerably higher compared to one year ago. For example, the 10-year US Treasury yield has increased from a record low of 0.5% in 2020 to 1.4% today (21 June). This trend is making some equity investors nervous, as all else being equal, higher yields erode the present value of future earnings and hence lower stock market valuations. The cyclically adjusted price-to-earnings ratio (CAPE), which divides stock prices by average profits over a 10-year period (in real/inflation-adjusted terms), tends to be inversely related to the level of real bond yields. Currently, US bond yields are at historical lows while valuations are at extreme highs, so the risk is that equity markets suffer if yields rise and valuations contract. However, rising yields do not always spell trouble for stock returns. The net effect can be positive if bond yields rise alongside an increase in risk appetite and valuations, as has been the case lately. Alternatively, earnings may grow fast enough to offset the negative impact of higher discount rates. But if earnings fail to grow fast enough, or if bond yields rise too quickly, markets may struggle to absorb the impact. Since the 1970s, there have been approximately 11 rising yield cycles. Yet, contrary to popular belief, these periods were overwhelmingly positive for the stock market. For example, US equities delivered a positive total return in nine of these episodes, with an annualised average performance of 13.4%. Around half of the time, equity markets were unable to absorb the impact of higher bond yields and so trailing price-to-earnings (P/E) valuations contracted. However, equities still fared well overall because earnings grew fast enough to offset the lower valuation multiple (% change in stock prices = % change in P/E x % change in earnings). Read More:  https://www.schroders.com/es/il/professional-investor/insights/markets/what-do-rising-bond-yields-mean-for-the-us-stock-market/?t=true