Bond yields rise: Charles Schwab analysts bullish on European equities

• Positive correlation between bond yields and stock prices
• 5 percent mark crucial
• Charles Schwab bullish on European equities

Both the recent and the expected return developments could have a positive impact on European equities and give them a boost – at least that’s what Charles Schwab’s experts believe. They expect European cyclical and value stocks to outperform.

Interest rates and stocks have moved in the same direction over the past 20 years. Before that, in the 1970s to 1990s, stocks typically fell when interest rates rose, according to Advisor Perspectives magazine, experts at Charles Schwab. US Treasury yields, meanwhile, have recently returned to pre-coronavirus levels. In Germany, ten-year bond yields are close to zero percent, the highest level since May 2019. Against this background, the Charles Schwab experts asked themselves how the relationship might develop in the future.

Relationship between bond yields and stocks

The yield on ten-year US government bonds is currently well below five percent. When interest rates were below this threshold both in the 1960s and since 2000, there was usually a positive correlation, so stocks and bonds moved in the same direction, Charles Schwab explains. If they were over five percent, however, a negative correlation could be observed, meaning they tended to move in opposite directions. As the experts go on to explain, stock returns tend to move in sync with economic growth prospects as this is reflected in corporate earnings, which in turn are one of the key drivers of stock market performance. But over time, bond yields have become more and more cyclical. Therefore, the experts of the US provider of financial services assume that the relationship between bond yields and economic activity will remain positive and the positive correlation between bond yields and stock prices will continue. “We believe global bond yields have more upside potential even if inflation moderates in 2022, as we expect,” the report said. Long-term inflation expectations in Europe and the US have stagnated over the past three months, but real yield prospects are improving as confidence in economic growth prospects grows and monetary policy begins to normalize. But: “Should inflation fail to stabilize in 2022, the subsequent rise in yields could have a negative impact on equities and the economic outlook. The current scenario has the potential to herald a return to a negative correlation between equity prices and bond yields.” the Charles Schwab experts.

European stocks at a glance

With rising bond yields, investors should now consider overweighting their equity allocation, the experts continue to advise. “Note that rising rates have historically been associated with European equities outperforming the US, and within European equities, value stocks outperforming growth stocks.”

“Rising interest rates should favor European equities as the proportion of shorter-dated and interest-rate-sensitive sectors in the index is larger,” Bloomberg quoted strategists led by Sharon Bell of Goldman Sachs, adding: “Europe also differs from the US in that valuations for much of the market don’t look particularly stretched compared to past multiples”. Citigroup strategists, led by Beata Manthey, were also upbeat in a recent statement seen by Bloomberg: “European stocks can falter at the first Fed rate hike, but then typically bounce back “.

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