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

Why spending more in early retirement can improve lifetime income

Conventional wisdom encourages retirees to preserve superannuation. But if those likely to qualify for the Age Pension later in life spend a little more today, it may deliver higher lifetime income and a more stable retirement.

Will you run out of money in retirement?

Fear of running out has become a defining retirement anxiety. Why do some retirees die with substantial wealth while others deplete their nest egg? Evidence suggests the answer is more complicated than we think. 

The investment that sidesteps the new tax traps

Tax rules have changed, but many investors are still using yesterday’s strategies. Insurance bonds may offer advantages for those seeking greater control, tax efficiency and certainty about their wealth.

Testamentary trusts have secured the CGT exemption

Treasury’s latest CGT reform draft delivers a win for testamentary trusts and deceased estates, exempting estate-derived gains from the 30% floor. However, questions on death and divorce rollovers remain unresolved.

Meg on SMSFs: What do we think about reversionary pensions these days?

Reversionary pensions have long been a staple of SMSF estate planning, but are they still the best option? Meg Heffron revisits a once-clear favourite and asks whether changing super rules have shifted the balance.

How does the 4% rule stack up?

The 4% rule has long been retirement's gold standard. But after a difficult period for investors, fresh analysis suggests a more conservative approach may significantly improve the chances of making savings last.

Latest Updates

Planning

Testamentary trusts survived the trust tax. The drafting battle has just begun.

The fight over testamentary trusts looked settled. Then the draft legislation arrived. Hidden in a technical detail is a question that could force many families to rethink wills they thought were already future-proof.

Investment strategies

The new capital gains tax trap for your portfolio

Investors have long accepted one portfolio rule without much question. A major tax shift could change that calculation entirely, forcing difficult trade-offs between risk, discipline and an overlooked cost lurking beneath.

Economy

Population growth masks Australia’s productivity problem

For years, investors have benefited from a seemingly reliable growth story. But recent national accounts raise uncomfortable questions about what has really been driving Australia’s economy and whether that can continue unchecked.

Investment strategies

Why tomorrow’s winners may not be today’s index leaders

The stocks that built retirement balances over the past decade now dominate many portfolios. The new challenge is whether these companies can continue meeting the increasingly high expectations embedded in today's share prices.

Investing

What earnings surprises reveal about future returns

Sometimes the most important information in an earnings result isn't the number itself. It's the possibility that the market's assumptions have been fundamentally wrong and future earnings may look very different.

SMSF strategies

Individual SMSF Trusteeship directly liable for ATO fines

A rarely discussed detail buried in SMSF structures could dramatically change who wears the cost when something goes wrong. With penalties rising, a decision many dismissed as administrative may deserve a second look.

Investment strategies

The currency bet you didn’t know you made

Buying global shares means making two bets: on the companies and on the Australian dollar. Most investors consciously choose only the first. Last financial year, the second bet cost 8.5% in returns for many investors.

Alliances

  • ASA-Logo-RGB-ActiveGreen-web.png

© 2026 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.