Changes in bond yields can have a major influence on equity markets because of the close relationship that exists between bond yields and equity prices. The following is a list of the ways that changes in bond rates can have an effect on the stock market:
- The competition for investment: bond yields and equities markets are both vying for the money that investors have to invest. When bond yields are high, investors may choose to put their money into bonds rather than stocks since bonds provide a more consistent return on investment. This can bring about a reduction in the demand for shares, which in turn can bring about a reduction in the price of equities.
2. Discounted cash flow: The study of discounted cash flow (DCF), which takes into account the current value of future cash flows, is frequently used as the basis for the valuation of stocks and other equity investments. Because they are utilised in the calculation of the discount rate, bond yields are an essential component of the DCF model. It is possible for equity valuations and prices to fall as a result of an increase in the discount rate, which occurs whenever bond yields go up.
3. Sensitivity to changes in interest rates Stocks are also susceptible to shifts in interest rates, which are closely tied to the yields on bond investments. When bond yields go up, interest rates also go up, which can make the cost of borrowing money for businesses more expensive. This can result in a fall in corporate profits, which in turn can lead to a decrease in the price of shares in the market.
4. The impact that differs depending on the industry Some industries are more susceptible to shifts in bond yields than others. Utility businesses, for instance, are sometimes compared to investments in bonds due to the fact that they provide consistent dividends and are less susceptible to fluctuations caused by economic cycles. As a result, when bond yields go up, it’s possible that utility equities will underperform relative to other industries.
Changes in bond yields can also have an effect on market mood, which brings us to our fifth and last point. As bond yields go up, this may be interpreted as either an indication that inflation is picking up or that the economy is becoming better. This can result in a rise in investor confidence, which in turn can lead to an increase in the price of equities.
While making decisions about their investments, investors should take into account the relationship between bond yields and equity markets because bond yields can have a major effect on the performance of equity markets. Investors might benefit from more educated investment selections if they have a solid understanding of how changes in bond yields can affect the value of equities.
