Rising borrowing rates – US 10-year bond yields have topped 5 per cent for the first time since 2007 – are bad news for governments, but are they also bad news for stock investors?
Perhaps. A “disorderly rise in bond yields” is the biggest tail risk facing markets, according to Bank of America’s latest monthly fund manager survey.
However, even without a “disorderly” spike, today’s yields give investors a more attractive alternative to stocks, making it harder for them to justify their risk.
Already, the gap between equity earnings yields and bond yields is unusually narrow, notes Schroders. This does not necessarily mean poor near-term performance, but looking further out, a narrow gap has historically been associated with weaker long-term stock returns.
The good news is strong earnings growth can provide a way out, as Schroders finds stocks have tended to defy a poor starting yield gap when real earnings growth is strong.
And right now, analysts expect plenty of it, with US earnings forecast to grow 32 per cent in 2026, 16 per cent in 2027 and again in 2028, and with long-term growth rates “higher even than in the dotcom era”.
If those numbers are remotely achievable, stocks can still comfortably beat bonds despite higher yields. If they are not, however, the attraction of a relatively risk-free 5 per cent becomes harder to ignore for investors.