Should Equity Investors Fear A De-Rating Phase? – March 15, 2021

The recent breakout in Treasury yields has had some contagion on growth stocks, and has raised the concern that a generalized de-rating in U.S. and global equities looms. Indeed, periods of rising bond yields and weakening earnings expectations have been lethal for stocks, although this is not currently the case. Rather, bond yields are rising because economic expectations are being significantly upgraded.

A similar picture developed 15-20 years ago, as highlighted in a just-published report. Bond yields rose steadily in the mid-2000s and stocks were de-rated, yet equity prices rallied because of rising earnings expectations.

A plausible outcome, especially for the relatively pricy U.S. equity market, is that the P/E ratio drifts lower as bond yields trend higher and stock prices lag the improvement in earnings (having already front-run better profits). Importantly, a major de-rating is unlikely if the global economy stays on a recovery path, as we expect, although we would expect P/E ratios to gradually erode.


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