Danger lurks in global markets transformed by rising bond yields

Just as an all-rally propels records in the S&P 500 and inflates risky assets, the bond market is sending a warning to investors that a rapid economic recovery has its own dangers.

Treasury yields have risen to their highest since the early days of the pandemic as the introduction of the vaccine and the potential for another huge The US stimulus package is reviving animal spirits and the prospect of inflation. But years of near zero rates and one Historical overhanging debt makes both stocks and bonds particularly vulnerable to deep losses if interest rates rise too far in a growth outbreak.

Risk focuses on duration, which is now nearing record highs as debt issuers around the world tend to sell longer maturities and coupon payments fall or evaporate altogether. Trillions of dollars are at stake given high levels of both stocks and bonds – and some fear a repeat of the 2013 tapering when then Fed Chairman Ben Bernanke triggered a hike in interest rates after suggesting the central bank would can start cutting back. purchases.

“There is more duration risk embedded in the markets than many realize,” said Gene Tannuzzo, a portfolio manager at Columbia Threadneedle.

As bond maturity measures flirt with records, investors can expect greater losses from higher yields. It is a risk that has a greater reverberation as many stock viewers warn that stocks are not immune and especially tech darlings are exposed.

There is already some pain to be seen. After two years of gains, the Bloomberg Barclays Global Aggregate Treasury Index is down to a loss in 2021, with a duration position just below a record high. Given that level and the roughly $ 35 trillion in bonds the index tracks, each percentage increase in yield would mean roughly $ 3 trillion in losses.

What makes matters worse, says Tannuzzo, is an aspect of the mathematical computation of bonds that is embedded in many securities that dictates that as interest rates go up, the duration will also go higher. This is mainly due to something called negative convexity – which also means that the prices of securities will fall at an increasing rate as interest rates rise.

The duration of the shares is a bit more difficult to understand. Some use dividend yields to calculate how many years it will take to get their capital back without any dividend growth, with more time equating to a higher duration – generally, a lower dividend rate means a higher duration.

Vulnerable techies

Growth stocks, strongly represented by technology companies, are an example of this. Rising returns will take a major hit to the discounted values ​​of their cash flows, much of which is expected in the future. And the weighting of technology stocks in major stock indices is greater than it was during the tech bubble of the late 1990s.