Moody’s warns of ‘jarring’ equity sell-off if bond yields rise

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A rise in bond yield runs the risk of “sinking” equities given the potential overvaluation of the stockmarket, according to analysis by Moody’s.

Stockmarkets have rallied strongly since the start of 2013, despite the global sell-off in June over fears of tapering by the US Federal Reserve. FE Analytics shows the S&P 500 is up about 25.5 per cent over the year to date, while the FTSE 100 has gained 13.4 per cent.

Moody’s Capital Markets Research chief economist John Lonski argues that equities are starting to looking expensive, saying US common equity could be overvalued by between 10 and 15 per cent given the modest outlook for profits and the recent climb in corporate bond yields.

In addition, the VIX index – a measure of S&P 500 index options’ implied volatility and often referred to as ‘the fear index’ – recently fell to 13 points, which is below the 16.1 median of the previous two business cycle upturns and evidence of “excessive confidence” in equity valuations, Lonski says.

“The current overvaluation of equities increases the vulnerability of share prices to higher bond yields, especially since the overpricing of shares largely stems from exceptionally low interest rates,” the economist explains.

“Unless there is strong reason to expect a pronounced and lasting acceleration of profits, a sudden upturn by the 10-year Treasury yield to 3 per cent or higher would prompt a jarring sell-off of equities. Not only will higher yields lessen the relative attractiveness of dividends, but costlier credit could worsen the outlook for profits.”