Rising bond yields impact stock prices in two ways. One being the real economic effect where a backup in yields causes growth to slacken and profits to drop, thereby placing downward pressure on stocks. The other is via a discounting factor. All else being equal, rising yields reduces the fair value of equities. However, our Global Investment Strategy service noted in its latest weekly bulletin, that even if 10-year Treasury yields were to hit 6%, stocks would still fail to become expensive compared to other competing assets. This message is consistent with our view that global equities would still be inexpensive compared with bonds if yields rose another percentage point in aggregate. Bottom Line: Recent equity market weakness should not be viewed as anything more than a bull-market correction. Further weakness is likely, but buying on dips is the right strategy.
This analysis furthers my argument that 5% - 6% yields on the 10-year Treasury aren't as alarming as the market has been thinking they were.
However, if someone finds a counter-argument, please let me know by posting it in the comments. I am open to changing my mind if the argument is solid.
1 comment:
5-6% is well within the range that has supported rising markets.
What makes it alarming to have yields at the high end has to do with what will happen should there be a recession: tax revenues will fall even as claims on revenue(especially through UE and Medicaid) rise. Declining revenues trigger higher deficits. Higher deficits trigger higher rates. If we were entering a recession with rates at 4%, no worries. But if we enter it with rates at 6%, then the danger is that a destructive spiral of declining expenditures + rising unemployment + painfully high rates could get started.
Charles of MercRising
http://www.phoenixwoman.wordpress.com
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