Bond Yields Are Rising: What's The Impact On Stocks?

Introduction

Bond yields have risen sharply over the past weeks/months, which is remarkable given the uncertainties that will last for several months and even years. The fact that stocks haven't benefitted from the cash outflow in bonds is even more surprising. The following evident question is: what does this mean for stocks? Has it already occurred previously, or does this act like a red flag?

Correlation to TLT: Risks Change

First of all, it does matter why rates are increasing. Is it because of inflationary pressure or improving economic fundamentals? In our opinion, the massive amount of 'free money' will inevitably lead to higher inflation (which lessens the damage of the debt burden).

Second, in case that inflation is indeed picking up: which sectors are set to benefit from that situation? REITs, consumer staples, utilities... have price escalation built in their business model. On the other hand, because of their robust cash flows and long-term visibility (regulation), these companies do show higher leverage metrics, albeit debt is generally financed at fixed long-term interest rates. So in essence: rising interest rates don't impact a well-run company. It's the stock market's perception that makes many believe the opportunity cost of choosing between bonds and stocks is still alive. As such, the impact of changes in interest rates doesn't pose problems to the companies on our premium watchlist. It is true that bank stocks tend to benefit from rising interest rates (Russell-2000), but there are many other factors that come into play as well.

Nonetheless, what's correlation looked like over the past years? Is there a tale to draw valid conclusions from? Let's find out.

PepsiCo

Let's take a look at PepsiCo, a consumer staples stock and longtime dividend aristocrat. On average, PEP isn't correlated with the TLT tracker (US Treasury Bonds 20-Year) on a 6-month basis (based on weekly closing prices). As you'll notice below, the stock market as a whole tends to be negatively correlated with bonds (when bond prices rise (interest rates going down), asset managers are rotating out of stocks into treasuries). The fact that PEP isn't that positively or negatively correlated to TLT under extreme circumstances indicates the relatively weak sensitivity to changes in interest rates. There are, however, periods during which PEP may exhibit higher correlation (like in 2013 when bond-proxy stocks were lagging the overall market). All in all, PEP doesn't exhibit pronounced relationship with neither the SPY or TLT.

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