The danger lurks in global markets transgressed by rising bond yields

Just as an all-out rally propels records in the S&P 500 and inflates risky assets, the bond market sends a warning signal to investors that a rapid economic rebound comes with its own dangers.

Treasury yields have soared to their highest since the early days of the pandemic as vaccine rollout and potential for another The American stimulus plan relaunches animal spirits and the prospect of inflation. But years of rates close to zero and one historic over-indebtedness has left stocks and bonds particularly vulnerable to heavy losses if yields rise too far during a break in growth.

The risk is centered on the duration, now near a record high, as debt issuers around the world shift their sales to longer maturities and coupon payments plunge or evaporate altogether. Billions of dollars are at stake given the high levels of stocks and bonds – and some fear a repeat of the taper tantrum of 2013 when then Fed Chairman Ben Bernanke triggered a surge in yields after he suggested that the central bank could start reducing its assets. purchases.

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

As measures of bond duration flirt with record highs, investors can expect larger losses from higher yields. It’s a risk that has wider reverberations, as many equity watchers warn that stocks are not immune and tech darlings are particularly at risk.

Some pain is already visible. After two years of gains, the Bloomberg Barclays Global Aggregate Treasury Index fell to a loss in 2021, with duration just below a record high. Given that level and the roughly $ 35 trillion bond stack that the index tracks, each percentage point increase in yield would mean roughly $ 3 trillion in losses.

What makes matters worse, Tannuzzo says, is an aspect of bond math built into many stocks that dictates that as yields rise, their duration will also increase. This is mainly due to something called negative convexity – which also means that the prices of securities will fall faster and faster as rates go up.

The duration of equity is a little more difficult to grasp. Some use dividend yields to calculate how many years it will take to recoup your capital without any dividend growth, with more time equating to a higher duration – basically a lower dividend rate means a higher duration.

Vulnerable technicians

Growth stocks, strongly represented by technology companies, are a good example. Rising yields will have a huge impact on the present values ​​of their cash flows, much of which is expected in the future. And the weighting of technology stocks in major stock market indices is greater than during the technology bubble of the late 1990s.