The danger arises in global markets transformed by rising bond yields

Just as a rally propels S&P 500 records and inflates risky assets, the bond market is sending investors a warning signal that a quick economic recovery is coming with its own dangers.

Treasury yields rose to one of the first days of the pandemic, as vaccine launches and the potential for another massive The US stimulus package is reviving animal spirits and the inflation outlook. But years of almost zero installments and a historical debt overruns have left both stocks and bonds uniquely vulnerable to deep losses if yields rise too high.

The risk is focused on duration, now almost a record, as debt issuers around the world lean sales towards longer maturities, and coupon payments fall or evaporate altogether. Trillions of dollars are at stake, given the high levels of both stocks and bonds – and some fear a repeat of the 2013 taper tantrum, when then-Fed Chairman Ben Bernanke triggered a rise in yields after suggested that the central bank could start reducing its acquisition assets.

“There are more long-term risks embedded in the markets than many can realize,” said Gene Tannuzzo, portfolio manager at Columbia Threadneedle.

As bond duration measures flirt with records, investors can expect higher losses from higher returns. It is a risk that has wider reverberations, as many stock watchers warn that stocks are not immune and technology lovers are particularly exposed.

Some pain is already exposed. After two years of gains, the Bloomberg Barclays global treasury index reached a loss in 2021, its duration remaining even below a record level. Given this level and the pile of bonds of about $ 35 billion that the index seeks, each one-point percentage increase in yield would mean losses of about $ 3 billion.

What makes things worse, says Tannuzzo, is an aspect of bond math embedded in many securities that dictates that as yields increase, their duration will increase even more. This is mainly due to something called negative convexity – which also means that securities prices will fall at an ever-increasing rate as rates rise.

The duration of equity is a little more difficult to understand. Some use dividend yields to calculate how long it will take to recoup your capital without a dividend increase, with more time equating to a longer duration – broadly speaking, a lower dividend rate means a longer duration. .

Vulnerable techniques

Growth stocks, strongly represented by technology companies, are an example. Rising returns will have a major impact on the discounted values ​​of their cash flows, many of which are expected in the future. And the share of technology stocks in major stock indices is higher than during the technology bubble of the late 1990s.