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Andy Constan

21 Oct, 12 tweets, 2 min read

Thoughts on Bond Equity correlation. The rise in interest rates has concerned some regarding equity markets.
30yr b/e are back to Spring highs
30 Year nominal rates are 30bp lower.
Real interest rates are have fallen.
How rates rise is important for equities

Equities are driven by earnings, long term risk free rates, and risk premium. I have written enough on RP for now so this thread will focus on the first two.

Let's be clear if risk free interest rates rise equities should fall due to the discount rate mechanism. However interest rates rarely rise for no reason and the rise flows through to earnings. The flow through can overwhelm the headwind of the discount rate mechanism

Or the flow through can itself be a headwind.

If interest rates rise because businesses are investing and need capital to meet demand and take advantage of growth real rates rise. This flow through is a strong tailwind to equities as it generates higher earnings.

If interest rates rise due to higher inflation. It's more complicated. Inflation is a positive for revenue providing a tailwind. Inflation is a negative for costs providing a headwind. Typically conflicting winds are both blowing and equities in most environments net benefit

The inflationary impact on average also is stronger than the discount rate headwind. Equities are an asset that benefits from inflation.

Where inflation becomes a headwind is in the late cycle when wages and inputs are going up faster than revenue. Also in such environments central bankers also tend to tighten monetary policy. This is why people focused on equities today

Will interest rates continue to go higher due to inflation expectations instead of real rates?

Huge moves in spot commodities, a labor shortage in certain sectors, rising wages in those sectors, the retirement narrative, supply chain breakages and the Feds own surprise and its literal have put late stage inflation on the table.

If this is correct and inflation expectations drive nominal rate higher in a bad for earnings way equities should fall a lot.

FWIW I think all of this fear is peaking. Nominal interest rates will fall. The taper is not a tightening and the Fed won't push forward lift off. As of the close of the week I have no position in bonds but am going to buy. I am also max long equities

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