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

Simple maths says the AI investment boom ends badly

This AI cycle feels less like a revolution and more like a rerun. Just like fibre in 2000, shale in 2014, and cannabis in 2019, the technology or product is real but the capital cycle will be brutal. Investors beware.

Why we should follow Canada and cut migration

An explosion in low-skilled migration to Australia has depressed wages, killed productivity, and cut rental vacancy rates to near decades-lows. It’s time both sides of politics addressed the issue.

Are LICs licked?

LICs are continuing to struggle with large discounts and frustrated investors are wondering whether it’s worth holding onto them. This explains why the next 6-12 months will be make or break for many LICs.

Australian house price speculators: What were you thinking?

Australian housing’s 50-year boom was driven by falling rates and rising borrowing power — not rent or yield. With those drivers exhausted, future returns must reconcile with economic fundamentals. Are we ready?

Retirement income expectations hit new highs

Younger Australians think they’ll need $100k a year in retirement - nearly double what current retirees spend. Expectations are rising fast, but are they realistic or just another case of lifestyle inflation?

Welcome to Firstlinks Edition 627 with weekend update

This week, I got the news that my mother has dementia. It came shortly after my father received the same diagnosis. This is a meditation on getting old and my regrets in not getting my parents’ affairs in order sooner.

  • 4 September 2025

Latest Updates

Shares

Why the ASX may be more expensive than the US market

On every valuation metric, the US appears significantly more expensive than Australia. However, American companies are also much more profitable than ours, which means the ASX may be more overvalued than most think.

Economy

No one holds the government to account on spending

Government spending is out of control and there's little sign that Labor will curb it. We need enforceable rules on spending and an empowered budget office to ensure governments act responsibly with taxpayers money.

Retirement

Why a traditional retirement may be pushed back 25 years

The idea of stopping work during your sixties is a man-made concept from another age. In a world where many jobs are knowledge based and can be done from anywhere, it may no longer make much sense at all.

Shares

The quiet winners of AI competition

The tech giants are in a money-throwing contest to secure AI supremacy and may fall short of high investor expectations. The companies supplying this arms race could offer a more attractive way to play AI adoption.

Preparing for aged care

Whether for yourself or a family member, it’s never too early to start thinking about aged care. This looks at the best ways to plan ahead, as well as the changes coming to aged care from November 1 this year.

Infrastructure

Renewable energy investment: gloom or boom?

ESG investing has fallen out of favour with many investors, and Trump's anti-green policies haven't helped. Yet, renewables investment is still surging, which could prove a boon for infrastructure companies.

Investing

The enduring wisdom of John Bogle in five quotes

From buying the whole market to controlling emotions, John Bogle’s legendary advice reminds investors that patience, discipline, and low costs are the keys to investment success in any market 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.