Investing.com — With the United States 10-Year up from 3.94% at the end of February to over 5% currently, UBS is out with a note weighing the effects in European equities, while pointing out that yields are rising for the right reason.
Rising yields are a headwind to valuations, but the impact is not uniform across the market, the firm noted. With the real yield up from 1.68% to 2.67% since February, equities have “absorbed the level better than the velocity.”
Since the beginning of March, weeks in which the 10Y rose averaged 42% of MSCI Europe index weight rising, versus 64% in weeks in which the yield fell, strategists at the firm noted.
“Controlling for the index return itself, every additional 10bp on the 10-year costs roughly 1pp of index weight participating,” they said. “The market is not falling on higher yields so much as narrowing under them.”
Furthermore, it is “the combination of level and speed” that breaks breadth, the firm said, highlighting how with the 10Y below 3%, even a >20bps weekly move saw over 57% of the index move higher as “rising yields were read as growth.”
However, when yields were between 4%-4.5%, breadth fell from 60% on down-yield weeks to 30% when yields were up over 20bps. Meanwhile, above 4.5%, the “level in isolation is benign.”
“It is the sharp weekly increase that does the damage: as the discount rate rises, the growth hurdle required to hold investor attention rises with it, and fewer companies clear it,” the firm said, adding that each incremental move requires more powerful earnings momentum to offset what is being priced into valuations.
Yields are however rising for the right reason, the firm said. “This is not a term-premium accident or an inflation scare. Yields are rising because growth is strengthening and, more importantly, broadening.”
For the first time in a generation, an industrial capacity expansion cycle is starting to emerge simultaneously across sectors including defence, AI equipment, infrastructure and power. This is important for rates because industrial activity “carries a higher velocity of money” compared to services.
“Markets have spent three decades in the opposite regime and are not well practised at pricing this one,” the firm noted.
Against this backdrop, the strategists view companies whose beta to rising yields is lowest as better investments given their cheaper valuations, and the fact that their earnings carry more cyclicality and growth.
“The distinction is not cyclical versus defensive in the abstract; it is whether earnings growth is accelerating fast enough, off a cheap enough starting valuation, to offset the multiple compression. Cyclical value has both.”
Related articles
What are the bond yield effects on European equities? UBS answers
Anthropic CEO Amodei to meet Trump privately ahead of AI summit
China may permit Alibaba, ByteDance to buy new Nvidia chips – The Information