How do Bond Yields impact the Equity Markets? | Relationship between US 10-year G-Sec Yield & Equity Markets￼3 min read
US bond market is one of the safest forms of investment and has investors across the country, bonds are debt instruments to raise funds. The interest payments remain largely unchanged over the life of the bond. Moreover, one receives the principal at the end of the bond tenure if the borrower doesn’t default. Bond yield, on the other hand, is the return that an investor gets on that bond or particular government security. An investor changes the allocation of their fund according to changes in these two markets. What is the relationship between US 10-Year G-Sec yields and equity markets? How does rising US G-Sec yield is affecting the attractiveness of Equity markets Here is a detailed explanation of this correlation between Debt Vs. Equity Asset Class.
Current US 10-Year & 30-Year G-Sec Yield and What is the relationship between US G-Sec Yield & Equity Markets?:
- During the pandemic, the lowest yield on 10-Year G-Sec was 0.33% but sustained at 0.50%, and currently, the 10-Year G-sec is around 2.95% and the 30-Year G-sec yield is around 3.032%.
- During the pandemic, the price-to-earnings ratio of the US G-Sec bond market was 200X while the P/E of the equity market was 30x/40x.
- Earning yield of the US G-Sec bond market was 0.33% while the earnings yield of the US equity market was 3.33%.
- Yield refers to the rate of return an investor can expect to earn if he/she holds a debt instrument until maturity. For instance, in the case of the US 10-Year G-Sec yield rate of 0.5%, it means if a person has invested Rs. 100, then he/she will be getting 50 paise as interest.
- At that point, the time equity market is more attractive than US G-sec because of the lower P/E ratio and higher-earning yield.
- The rising demand for bonds led to a fall in the interest rates of the bonds.
Price to Earnings Ratio of US 10-year G-sec Yield:
P/E Ratio of Yield Vs. Equity Market
Price to Earnings (P/E) Ratio: Current Price/Earnings Yield
- Price to Earnings Ratio of a bond can be calculated similar to the method of calculating the P/E ratio of a stock, just by replacing it with Earnings Per Share with Earnings Yield. The Price to Earnings Ratio of the bonds can be calculated with the following formul
- So, at the earnings yield of 0.50%, the P/E of the US 10-Year G-Sec Yield stands at 200X which is 30 to 40 times larger than the prevailing P/E of Equity Markets which was 30X.
- The earnings yield of equity which stood at around 3.33% as against 0.50% of the US 10-Year G-Sec Yield made the equity asset class more attractive to the investors.
Growth in Earnings Yield of Debt vs Equity Asset Class:
- Currently, US G-sec P/E is around 33.33x, and earnings are 3% while the US equity market (Dow Jones Index) currently has a P/E of 20x and earnings yield is 5%.
- While looking at the earnings yield in the both debt and the equity market, we can observe the growth in both the market.
- US equity market (Here, Dow Jones Index) has witnessed a growth of 50% while the US G-Sec has grown approx. 500% from pandemic to the current period.
- Now, comparing both market debt class instruments has shown very attractive growth, which might create some problems for the equity market as investors will start moving from equity to debt class instruments.
- Federal Reserve will increase the rate slowly and gradually, but the market has already started reacting to it.
- Inflation will be seen for some more time so to control it the hike in the rate will continue for around 12-18 months.
What Should Shareholders Do?
Bonds are more attractive than the equity market at this point but as an investor one should be a little optimistic about directly changing their asset class as inflation is also rising. Also, completely ignoring this growth is not worth it. In the current situation, there is a solution to make proper allocation of the fund. But the liquidity support will be mostly given to the debt instrument. This year 2022 could be the year of acquisition and here one should welcome the rationality in the market.
Disclaimer: The information here is provided for reference purposes only and should not be misconstrued as investment advice. Under no circumstances does this information represent are commendation to buy or sell stocks or MF.