Fissures in the U.S. bond market may be about to claim their latest victim: High-flying Asian equities.
According to HSBC, risks for Asian stock markets have risen because higher bond yields stateside could push up the cost of equity for companies in the region, undermining valuations.
Asia's stocks have fared better than their U.S. peers despite a recent wobble, with the MSCI Asia ex-Japan index rising 6.54 percent so far this year, outpacing the 3.94 percent rise in the S&P 500. But that could be about to change, at least in the near-term.
Equity valuations are influenced by both the return on equity (ROE) as well as the cost of equity (COE). The former has a direct correlation with valuations, while the latter has an inverse relationship.
And this is where the recent widening of the gap between 2-year and 10-year Treasury yields is expected to have a bearing, even though risks on ROE have diminished.
According to the widely followed Capital Asset Pricing Model (CAPM) method, cost of equity partly depends on bond yields (expressed as the risk free rate). A rise in bond yields could therefore push up the cost of equity.
The market risk premium and beta—a measure of the sensitivity of the returns on an asset or a portfolio to broader market returns—are the other variables in the CAPM method.