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Increasing bond yields | What it means for equity investors

Stock markets across the globe have fallen recently due to rising bond yields. Let us understand the relation between bonds and equities and try to figure out whether this fall will continue or it is just an overreaction of slight increase in bond rates and markets will rally again.

Nifty - Last 5 days chart
Government bond yield - Last 5 days chart

Bond yield and equities have inverse relation, in general which we can see in published charts. However, it is not absolute relation because equities can move up or down due to a lot of other factors also but recent fall was primarily due to concerns over increasing bond yields. If bond rates are high, it is very obvious that few investors will move to bonds from equity as it is safer option and your capital is protected. 

Stocks are risky by nature. You can lose your entire capital forget about dividend or capital appreciation. Whereas bonds are secured, in general and if it is government bond then of course it is backed by government and hence in no case you will lose anything practically. Your principal and interest on top of that is secured and guaranteed. 

So, when can we expect investors withdrawing money from equity and moving towards bond. It is very judgmental, however when the gap between bond yield and equity return is very low e.g. if equity is giving on an average 12% CAGR and bond is giving 10% return, in this case we can see a shift towards bond and very limited fresh investments in equity. Which used to be the case in India, if you see bond or bank fixed deposit rates before 2000s and link this with equity investments in India, you will see a relation. Very few people were interested in equities back then as they were able to get 12% to 14% return from bonds or bank deposits. And when bond interest rates are so high, equities are expected to give at least 25% return in my opinion to attract investors which is very difficult.

10 year bond yield chart (Tradingeconomics.com)

However, now as bond rates are hovering around 6% in India, which is barely covering inflation and equity indices are giving 12% to 15% CAGR, in my opinion, it is not the right time to say that markets will fall and money will move to bonds. Further, if we see bond rates of other countries, it is even negative in some European countries and just approx 1.6% in US. So, even if we assume that some chunk of our domestic money will go to bonds, global cheap money has no option but equity and India is best positioned in today's time to attract global money.

So, stay invested and let me know you views in comment box below.


About author: 

Manish Negi is a Chartered Account and an experienced auditor. 

Twitter -  www.twitter.com/camanishnegi

Koo - www.kooapp.com/profile/camanishnegi

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