Sky high bond yields: a reckoning for equity investors?
A falling U.S. dollar, China and Russia stacking gold and angling to take Taiwan, surging U.S. debt and a President dismantling the independence of America’s central bank. It’s no wonder bond yields are high.
Fiscal recklessness is stirring in the bond markets, and long-dated government debt appears to be under siege once again. Yields on 30-year U.S. Treasuries were at 4.97 per cent at the start of September – now at 4.66 per cent – and near their highest level since 2007, Britain’s 30-year gilts spiked to a 27-year high of 5.75 per cent at the start of September, while Japan’s 20-year notes flirted with levels unseen since 1999. French and Australian sovereign bonds yields are soaring too.
While some of the pressure has come out of bond yields in recent days, it seems bond traders are reassessing ballooning deficits, stubborn inflation, and political meddling that erodes faith in policymakers’ resolve.
For equity investors, who are accustomed to bonds being the sleepy and negatively correlated anchor in a diversified portfolio, the surging yields mark the return of “bond vigilantes” – those traders who punish profligate governments by demanding steeper yields and returns for lending to those same governments.
Back in 2022, U.S. 10-year bonds surged from 1.498 per cent to 3.83 per cent by the end of the year. The 30-year bond yield rose from 1.9 per cent to 3.82 per cent. That year U.S. equities, as measured by the S&P 500 fell just shy of 20 per cent. Today, both ten and thirty-year yields are higher than at the end of 2022, and yet the stock market is up 72 per cent.
This is despite the fact higher borrowing costs could cascade through economies, constraining corporate profits and igniting a correction in overvalued stocks, just as the artificial intelligence (AI)-fuelled bull market begins to tire.
Since the 2008 Global Financial Crisis (GFC), governments have avoided recessions by kicking the can down the road and gorging on cheap debt. Then, as COVID hit the global economy’s pause button, trillions more debt has been heaped on.
According to the Institute of International Finance, global indebtedness has risen from US$314 trillion last year to a staggering US$324 trillion with China, France, and Germany leading the charge. And just as the debt soars, the post-pandemic economy delivered surging inflation.
In response, central banks hiked rates aggressively, dismantled, unwound or reversed quantitative easing, and in so doing, dumped bonds back into the market.
The result?
Surging yields.
As I alluded to earlier, the U.S. is the epicentre of the economist’s unease. Donald Trump’s fiscal profligacy, enacted through his One Big Beautiful Bill Act, which the U.S. Congressional Budget Office estimates will balloon the deficit by US$3.4 trillion over the next decade, combined with a Moody’s rating downgrade that stripped the U.S. of its triple-A crown, and Trump’s erosion of central bank independence, are all converging to questions the equity investor’s optimism.
Of course, all of the above is well known, and the stock markets surge apace. That suggests it won’t be any of those factors that trigger a correction. Or will they?
Elsewhere, Britain’s Chancellor Rachel Reeves is staring down a brutal October budget, France teeters on governmental collapse amid parliamentary gridlock, Japan is now contending with inflation and a 30-year Japanese Government Bond (JGB) yield at record levels, and a near US$90 billion deluge of corporate investment-grade bond issues has squeezed out demand from sovereigns.
For equity investors, while the implications can be ignored, they must be acknowledged as insidious. When long-term yields leap, the effects ripple outward, impacting everything in the pond. Remember, bond rates act on asset values the way gravity acts on everything on Earth. The higher the yield, the heavier the effect.
Meanwhile, mortgage rates climb, auto loans tighten, and credit card bills swell, squeezing consumer spending – that powers 70 per cent of the U.S. economy, and companies face pricier refinancing, eroding margins in a landscape already strained by ebbing growth.
And that says nothing about the stretched market valuations. Spiking yields are occurring at the same time Nvidia Corp. is flashing warning lights. The AI chip titan, whose lofty rise has shepherded global indices higher for over a year, has fallen as much as eight per cent from its recent all-time highs, although it has since recovered much of those falls. Data-centre revenue, which is Nvidia’s lifeblood, undershot expectations, perhaps also reflecting changing conditions at its biggest customers –Microsoft, Meta, Amazon, and Alphabet – who are responsible for nearly half NVIDIA’s sales. And then there are the whispers of Chinese rivals like Alibaba’s in-house chips.
With the S&P 500 and Nasdaq at stretched and historically high valuations, equities persist at records, buoyed by AI euphoria and rate-cut hopes, and simultaneously dismissing fragilities like geopolitics, trade wars, and tepid growth.
But gold, passing US$3,500 an ounce, is a tacit vote of no confidence in fiat stability, suggesting a resignation that governments lack a “silver bullet” with no combination of austerity or easing expected to restore balance.
And that could mean bond rates around here, represent the new normal. And if borrowing costs remain higher-for-longer, what does that mean for equities?
In the 1990s, bond vigilantes forced Bill Clinton into deficit discipline; in 2022, they toppled Truss in the UK. Today, persistently higher yields inflate debt-servicing costs and force more borrowing, begetting higher yields.
Equity market gains depend on earning growth. Rising bond yields, however, are a profit killer, raising debt costs directly and slowing economic growth, which caps revenue and raises the cost of buybacks and expansion.
As always, the path forward is uncertain. And that means complacency is the real risk. More frequent rebalancing and keeping a closer eye on bond yields is probably called for.
Roger Montgomery is the Founder and Chairman of Montgomery Investment Management. Roger has over three decades of experience in funds management and related activities, including equities analysis, equity and derivatives strategy, trading and stockbroking. Prior to establishing Montgomery, Roger held positions at Ord Minnett Jardine Fleming, BT (Australia) Limited and Merrill Lynch.
He is also author of best-selling investment guide-book for the stock market, Value.able – how to value the best stocks and buy them for less than they are worth.
Roger appears regularly on television and radio, and in the press, including ABC radio and TV, The Australian and Ausbiz. View upcoming media appearances.
This post was contributed by a representative of Montgomery Investment Management Pty Limited (AFSL No. 354564). The principal purpose of this post is to provide factual information and not provide financial product advice. Additionally, the information provided is not intended to provide any recommendation or opinion about any financial product. Any commentary and statements of opinion however may contain general advice only that is prepared without taking into account your personal objectives, financial circumstances or needs. Because of this, before acting on any of the information provided, you should always consider its appropriateness in light of your personal objectives, financial circumstances and needs and should consider seeking independent advice from a financial advisor if necessary before making any decisions. This post specifically excludes personal advice.
