In this Viewpoint Equity, we revisit the relationship between bond yields and equity markets as government bond yields reach multi-year highs. Contrary to conventional wisdom, higher yields are not necessarily a headwind for stocks when accompanied by resilient growth and strong earnings.
We analyse the drivers behind recent yield moves, the role of bond volatility and earnings momentum, and explain why selectivity remains crucial. Against this backdrop, we highlight the sectors and metrics we believe are best placed to outperform in a higher-yield environment.
Key takeaways
- Equities can perform well despite elevated bond yields. When higher yields reflect resilient economic growth and are accompanied by strong earnings, equity markets can absorb the headwinds from higher discount rates, increased financing costs and stiffer competition for capital.
- The speed of yield increases matters as much as their level. Rapid repricing, particularly when driven by inflation surprises or tighter monetary policy, tends to unsettle equities, while markets can absorb higher yields more readily when adjustments are gradual.
- The equity outlook remains constructive, supported by strong earnings growth amid the ongoing investment cycle. However, elevated yields leave less room for multiple expansion, increasing the importance of earnings delivery while persistent bond volatility and stickier-than-expected inflation remain key risks.
- We favour quality companies with durable earnings growth and exposure to structural investment trends. We prefer technology, industrials and financials, while remaining cautious on more rate-sensitive areas where limited earnings growth compounds the challenges from higher yields.
