Tom & Jerry game of Bond and Stocks

March 4th we witnessed a fall in Equity markets and the main news that was flashing everywhere was the rise in the US bond yields. The fact: The 10-year US treasury benchmark has moved up to 1.50 percent ( which is a high move for the instrument ), and it is likely to rise further.

Equity markets have normally (with few exceptions) moves negatively with bond yields.

What does that mean ?

That means as bond yields go down stock market tend to outperform by a bigger margin .As bond yields go up equity markets tend to falter. This relationship may not exactly hold in the very short run.

Simply put Bond Yields are inversely proportional to Stock Yields.

This exactly happened on March 4th affecting US markets and then ripple effect of the mother US market was seen in other global markets.

Now these are the 2 primary reasons on why this happens, let us explore : 1. Opportunity cost of Stocks Bond yields, in a way, represent the opportunity cost of investing in equities. For example, if the 10 year bond is yielding 7% per annum then the equity markets will be attractive only if it can earn well above 7%. In fact, equity being risky there will have to be a risk premium,

As bond yields go up the opportunity cost of investing in equities goes up and therefore equities become less attractive. That is the first reason that explains the negative relationship between bond yields and equity markets. 2. Foreign Institutional flows When the bond yields in India go up, global investors find Indian debt more attractive in relation to global debt. This leads to capital outflows from equities and inflows into debt.

Again the essential point is that that FIIs look at Indian equity and debt as competing asset classes and allocate according to comparative yields.

Krishna Mohan

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