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Rise in real bond yields may slow but not stop stock market bulls

The sudden surge in inflation-adjusted bond yields this month rocked TINA, the thesis that “there is no alternative” to stocks, but if history guides us, stocks should resist this rise in real interest rates or even prosper.


With 10-year inflation-adjusted U.S. bond yields below minus 1%, many investors view stocks as the only current asset capable of generating high returns.


TINA is believed to have driven the nearly US $ 1 trillion inflows into global equity funds last year, a figure that BofA data shows topped the combined inflows of the previous two decades.


However, with US inflation peaking at around 7% and the Federal Reserve likely to hike interest rates 3-4 times this year, real yields – the nominal interest rate paid by a bond minus the rate d inflation – are on the rise.


Stocks fell after a spike in US yields. The impact has been particularly severe on the technology-intensive Nasdaq 100 index, where stocks trade on the principle of exceptional future earnings growth, making them particularly vulnerable to higher interest rates.


The Nasdaq is expected to experience its second worst start to the year since the 2008 crisis, coinciding with a 40 basis point jump in ten-year inflation-adjusted yields since December 30.


But banks, including JPMorgan and Goldman Sachs, are still advising clients to buy the downside, arguing that real yields remain deeply negative around -0.8%, that higher interest rates are already being factored in and that corporate earnings are strong.


Importantly, stocks have performed well in many previous bouts of rising real returns, provided economic growth holds. Bernstein notes, for example, that during the last five rounds of real rate “normalization” in 1975, 1980, 2012-2013, 2016 and 2020-2021, global stocks have returned between 2.3% and 51, 8%.


“Historically, when real returns have gone back to zero from negative levels, stocks have had positive returns,” Bernstein strategists Sarah McCarthy and Mark Diver told clients.


Separately, data from Truist Advisory Services shows that the S&P 500 has posted positive returns in 11 of 12 cycles of real rate hikes since the 1950s.


Additionally, real yields are expected to rise at a more gradual rate and will not hurt markets or economic activity until they actually turn positive, JPMorgan said, forecasting year-end levels around -0.25%.


In the meantime, the trend should prompt further sector shifts – higher real returns tend to be bad news for tech stocks, but financials, commodities, and cyclical stocks such as travel in China. generally benefit, JPMorgan wrote.


Behind the tech sell-off lies the premise that higher interest rates will lower stock valuations. Typically, a sustained 100bp rise in US TIPS yield results in a 20% drop in the price / earnings multiple, said Luca Paolini, chief strategist at Pictet.


Ultra-low rates have boosted equity valuations globally, but those of tech stocks, often viewed as ‘long-lived’ assets negatively correlated with rising bond yields, have exploded to what some consider like bubble territory.

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