Worried by the sudden rise in bond yields?
Fear not. On Friday, HSBC analysts provide us with a “what to do if bond yields rise” scenario map.
Mostly, they note, it’s not a problem because in the grand scheme of things bond yields are still at very low levels.
However, there is some strategy that could be implemented. Here’s more from HSBC’s Peter Sullivan, Robert Parkes and Garry Evans:
The correlation is most positive when real bond yields are below 2%. It remains positive when real bond yields are below 4% and only turns negative at real bond yields above 4% (chart 2). Real bond yields above 4% are a threat to equities, in our view, because this is when they threaten to choke off investment spending. It matters little whether we look at real or nominal bond yields. The pattern is similar for both (chart 3).
We have already mentioned the caveats. A sharp rise in bond yields is a threat from whatever level. Also, there are many reasons why signals from bond markets might be distorted by all the unconventional monetary measures that have been tried over the past three years. In our view, these will add an element of uncertainty but are unlikely to change the logic that the principal threat from bonds to equities is when bond yields rise high enough to dampen investment spending.
The key message for sector strategy being…
…that cyclicals tend to outperform when bond yields rise. The silver lining of higher bond yields is usually that nominal demand is rising and this will tend to favour cyclicals over defensives. IT, energy, materials and industrials consistently outperform when bond yields rise (chart 6). Healthcare and consumer staples are the main casualties. We have examined eight periods of rising bond yields since 1980 and consumer staples generally underperformed (chart 5).
Best to stay clear of those consumer staples just in case then…