Falling bond yields have been a common theme of 2019, the yield of the U.S. 10-year has fallen over 73bps since its recent high in November 2018. U.S. bond yields have been weighed down by falling bond yields in international markets, currently 29% of global government bonds yield below 0%. The impact of low, or even no yield, in bond markets has reignited the hunt for yield as investors have flooded to higher yielding asset classes, such as U.S. high yield and convertibles, looking for better returns. However, bonds do not work in isolation and there are important takeaways for equity investors. .
As we highlight in the below chart, a side-effect of lower bond yields is typically higher equity market multiples. The theory behind this relationship, is that equity prices are a function of future cash-flows discounted back at an appropriate interest rate. In today’s investment environment rates are lower, this inflates the value of future cash flows and pushes equity market multiples higher.
With global inflation expectations muted and central banks on hold, it looks likely that yields will remain lower for longer. Investors therefore are likely to see inflated equity multiples for the foreseeable future, helping support performance. However, investors should be cautious about overpaying for equities at this late stage in the economic cycle. For the time being economic growth looks solid but should conditions deteriorate expensive equity valuations can damage portfolio performance as multiples correct.
To learn more about the impact of negative bond yields, read my latest article, Fixed Income: Why all the negativity?
S&P 500 P/E ratio versus U.S. 10-year yields
Source: IBIS, Shiller, FactSet, J.P. Morgan Asset Management. IBIS NTM estimates are used until 1985. Between 1975 and 1985, CAPE-Shiller P/E ratios are used Data are as of April 30, 2019.