Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 410

Rising real yields likely to undermine equity values

In the United States, the economy has recouped nearly all the ground lost during the pandemic, and corporate earnings aren’t far behind. As I wrote in Firstlinks in April, 'A year like few others but what's next?', risk assets have discounted this V-shape recovery but as economic and earnings data evolves from forecast into fact, markets are looking ahead to see what’s next.

I believe what’s next will be a day of reckoning as investors grapple with higher yields. Here’s why.

Every investment opportunity is ultimately weighed against competing possibilities for use of funds. The decision to allocate capital happens only if the investment will clear its hurdle rate. While the height of every investment hurdle is determined by its idiosyncratic risk, real, inflation-adjusted interest rates are the first input into that calculus.

Anchors aweigh

During the 2020 recession, central bankers were determined not to allow lockdowns to morph into a credit crisis. In order to buoy animal spirits, policymakers drove real US Treasury yields deeply into negative territory, as illustrated in Exhibit 1 below.

In the years leading up to the pandemic, the real yield on the 10-year US Treasury Note lived in a meagre range below 1%, but at least it was positive and provided investors with some sort of measuring stick.

However, financial theory holds that asset prices can’t go negative. Since capitalism requires a hurdle rate, business school courses don’t teach students how to value a company or a project with negative nominal or real interest rates.

Without an anchor, it’s apparent why risk assets have risen as they have. Exhibit 2 overlays the advances made by the S&P 500 and MSCI World indices from their pandemic lows against the path of U.S. 10-year Treasury real yields into negative territory.

(The Standard & Poor’s 500 Stock Index measures the broad US stock market. The MSCI World Index measures stock markets in the developed world).

While there’s much sell-side research contending that risk assets can absorb inflation and higher rates, there’s an observable inverse correlation in the chart above that I think is causal and not coincidental. Since rates are the first hurdle in the valuation of any asset, higher rates, whether real or nominal, lower the value of that asset.

Negative real yields are unsustainable

As economies continue to reopen and excess savings are spent, inflationary pressures will continue to mount. We’re seeing it in goods such as lumber, semiconductors and automobiles; in services such as airfares, rental cars and vacation rentals; and in hard assets such as commodities and real estate.

Ultimately, we believe these pressures will prove transitory as the secular disinflationary forces of the past decade-plus — elevated debt levels, aging demographics and continued digitalisation, to name three — reassert themselves.

However, we’re confident that negative real rates are unsustainable and will eventually normalise. What we’re less confident about is the timing or the rate at which real yields will rise.

Regime shifts are always clear in hindsight but rarely at the point of inflection, yet markets have a way of sniffing them out. And when they do, we suspect that the relationship displayed in Exhibit 2 will reverse as rising real yields undermine equity valuations. As we go from forecast to fact, we believe market performance and leadership will look materially different than they have in the past several quarters.

 

 

Robert M. Almeida is a Global Investment Strategist and Portfolio Manager at MFS Investment Management. This article is for general informational purposes only and should not be considered investment advice or a recommendation to invest in any security or to adopt any investment strategy. Comments, opinions and analysis are rendered as of the date given and may change without notice due to market conditions and other factors. This article is issued in Australia by MFS International Australia Pty Ltd (ABN 68 607 579 537, AFSL 485343), a sponsor of Firstlinks.

For more articles and papers from MFS, please click here.

Unless otherwise indicated, logos and product and service names are trademarks of MFS® and its affiliates and may be registered in certain countries.

 

RELATED ARTICLES

Is there any point in holding cash?

The bank is still a terrible place to put your money

Dividends strong as some things change, some stay the same

banner

Most viewed in recent weeks

Finding the best income-yielding assets

With fixed term deposit rates declining and bank hybrids being phased out, what are the best options for investors seeking income? This goes through the choices, and the opportunities and risks involved.

What history reveals about market corrections and crashes

The S&P 500's recent correction raises concerns about a bear market. History shows corrections are driven by high rates, unemployment, or global shocks, and that there's reason for optimism for nervous investors today. 

Howard Marks: the investing game has changed

The famed investor says the rapid switch from globalisation to trade wars is the biggest upheaval in the investing environment since World War Two. And a new world requires a different investment approach.

Welcome to Firstlinks Edition 605 with weekend update

Trump's tariffs and China's retaliatory strike have sent the Nasdaq into a bear market with the S&P 500 not far behind. What are the implications for the economy and markets, and what should investors do now? 

  • 3 April 2025

Designing a life, with money to spare

Are you living your life by default or by design? It strikes me that many people are doing the former and living according to others’ expectations of them, leading to poor choices including with their finances.

World's largest asset manager wants to revolutionise your portfolio

Larry Fink is one of the smartest people in the finance industry. In his latest shareholder letter, the Blackrock CEO outlines his quest to become the biggest player in private assets and upend investor portfolios.

Latest Updates

Investment strategies

An enlightened dividend path

While many chase high yields, true investment power lies in companies that steadily grow dividends. This strategy, rooted in patience and discipline, quietly compounds wealth and anchors investors through market turbulence.

Investment strategies

Don't let Trump derail your wealth creation plans

If you want to build wealth over the long-term, trying to guess the stock market's next move is generally a bad idea. In a month where this might be more tempting than ever, here is what you should focus on instead.

Economics

Pros and cons of Labor's home batteries scheme

Labor has announced a $2.3 billion Cheaper Home Batteries Program, aimed at slashing the cost of home batteries. The goal is to turbocharge battery uptake, though practical difficulties may prevent that happening.

Investment strategies

Will China's EV boom end in tears?

China's EV dominance is reshaping global auto markets - but with soaring tariffs, overcapacity, and rising scrutiny, the industry’s meteoric rise may face a turbulent road ahead. Can China maintain its lead - or will it stall?

Investment strategies

REITs: a haven in a Trumpian world?

Equity markets have been lashed by Trump's tariff policies, yet REITs have outperformed. Not only are they largely unaffected by tariffs, but they offer a unique combination of growth, sound fundamentals, and value.

Shares

Why Europe is back on the global investor map

European equities are surging ahead of the U.S this year, driven by strong earnings, undervaluation, and fiscal stimulus. With quality founder-led firms and a strengthening Euro, Europe may be the next global investment hotspot.

Chalmers' disingenuous budget claims

The Treasurer often touts a $207 billion improvement in Australia's financial position. A deeper look at the numbers reveals something less impressive, caused far more by commodity price surprises than policy.

Fixed interest

Duration: Friend or foe in a defensive allocation?

Duration is back. After years in the doghouse, shifting markets and higher yields are restoring its role as a reliable diversifier and income source - offering defensive strength in today’s uncertain environment.

Sponsors

Alliances

© 2025 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. To the extent any content is general advice, it has been prepared for clients of Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), without reference to your financial objectives, situation or needs. For more information refer to our Financial Services Guide. You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.