Dangers occurring in world markets modified by rising bond yields

Just as a rally of everything drives S&P 500 records and inflates risky assets, the bond market is issuing a warning signal to investors that a rapid economic upturn carries its own dangers.

Treasury yields have skyrocketed since the early days of the pandemic, as the launch of the vaccine and the potential for another massive The U.S. stimulus package is reviving animal spirits and the inflation outlook. But years of almost zero rates already the historical debt overload has left stocks and bonds only vulnerable to deep losses if yields rise too high in a burst of growth.

Risk is focused on duration, now almost historic, as debt issuers around the world tip sales toward longer maturities and coupon payments fall or evaporate completely. There are trillions of dollars at stake, given the high levels of both stocks and bonds, and some fear that the tonic rage of 2013 will be repeated when then-Fed Chairman Ben Bernanke caused a rise in yields after suggesting that the central bank could begin to reduce assets. shopping.

“There’s more duration risk embedded in the markets than many may realize,” said Gene Tannuzzo, portfolio manager at Columbia Threadneedle.

As measures of bond duration flicker with records, investors can expect greater losses from higher returns. It is a risk that has wider reverberations, as many equity observers warn that stocks are not immune and that technology lovers are especially exposed.

Some pain is already showing. After two years of gains, Bloomberg Barclays ’aggregate aggregate treasury index has fallen in losses in 2021, lasting just below a record high. Given this level and the approximately $ 35 trillion in bonds that the index follows, each percentage increase in yield would mean a loss of about $ 3 trillion.

What makes things worse, Tannuzzo says, is one aspect of bond math embedded in many titles that dictates that as yields increase, their duration will also increase. This is mainly due to something called negative convexity, which also means that stock prices will fall at an ever-increasing rate as rates rise.

The duration of the equity is a little harder to understand. Some use dividend yields to calculate how many years it will take to recoup capital without any dividend growth, with more time equating to a longer duration: broadly speaking, a lower dividend rate means a longer duration.

Vulnerable techniques

Growth stocks, strongly represented by technology companies, are an example. The increase in yields will produce great success in the discounted values ​​of their cash flows, much of which is expected in the future. And the weighting of technology stocks in major stock indices is higher than that of the technology bubble of the late 1990s.