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.

 

  •   2 June 2021
  • 2
  •      
  •   

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

The growing debt burden of retiring Australians

More Australians are retiring with larger mortgages and less super. This paper explores how unlocking housing wealth can help ease the nation’s growing retirement cashflow crunch.

Four best-ever charts for every adviser and investor

In any year since 1875, if you'd invested in the ASX, turned away and come back eight years later, your average return would be 120% with no negative periods. It's just one of the must-have stats that all investors should know.

LICs vs ETFs – which perform best?

With investor sentiment shifting and ETFs surging ahead, we pit Australia’s biggest LICs against their ETF rivals to see which delivers better returns over the short and long term. The results are revealing.

Family trusts: Are they still worth it?

Family trusts remain a core structure for wealth management, but rising ATO scrutiny and complex compliance raise questions about their ongoing value. Are the benefits still worth the administrative burden?

13 ways to save money on your tax - legally

Thoughtful tax planning is a cornerstone of successful investing. This highlights 13 legal ways that you can reduce tax, preserve capital, and enhance long-term wealth across super, property, and shares.

Our experts on Jim Chalmers' super tax backdown

Labor has caved to pressure on key parts of the Division 296 tax, though also added some important nuances. Here are six experts’ views on the changes and what they mean for you.        

Latest Updates

Retirement

Why it’s time to ditch the retirement journey

Retirement isn’t a clean financial arc. Income shocks, health costs and family pressures hit at random, exposing the limits of age-based planning and the myth of a predictable “retirement journey".

Financial planning

How much does it really cost to raise a child?

With fertility rates at a record low, many say young people aren’t having kids because they’re too expensive. Turns out, it’s not that simple and there are likely other factors at play.

Exchange traded products

Passive ETF investors may be in for a rude shock

Passive ETFs have become wildly popular just as markets, especially the US, reach extreme valuations. For long-term investors, these ETFs make sense, though if you're investing in them to chase performance, look out below.

Shares

Bank reporting season scorecard November 2025

The Big Four banks shrugged off doomsayers with their recent results, posting low loan losses, solid margins, and rising dividends. It underscores their resilience, but lofty valuations mean it’s time to be selective. 

Investment strategies

The real winners from the AI rush

AI is booming, but like the 19th-century gold rush, the real profits may go to those supplying the tools and energy, not the companies at the centre of the rush.

Economy

Why economic forecasts are rarely right (but we still need them)

Economic experts, including the RBA, get plenty of forecasts wrong, but that doesn't make such forecasts worthless. The key isn't to predict perfectly – it's to understand the range of possibilities and plan accordingly.

Strategy

13 reflections on wealth and philanthropy

Wealth keeps growing, yet few ask “how much is enough?” or what their kids truly need. After 23 years in philanthropy, I’ve seen how unexamined wealth can limit impact, and why Australia needs a stronger giving culture.

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.