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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.
Yields in major developed markets have climbed in recent sessions as doubts emerged over the efficacy of excessive monetary stimulus as well as concerns over the pace and extent of the rally in the bond market.
The rise in U.S. bond yields, if it spills over to Asia, could push up the cost at which future earnings are discounted, hurting valuations.
"As we face the risk that central banks might not bail investors out, the curve will steepen," the HSBC analysts said.
"Higher U.S. bond yields and a steeper yield curve could pour some cold water over Asian credit and, in light of the high correlation between Asian credit and regional equities, Asian stock markets."
There is a track record of rumblings in the U.S. bond market casting a pall over Asian stocks, HSBC said, noting that monthly returns were significantly lower in previous episodes of U.S. curve steepening.
The most vulnerable markets? The Philippines, Indonesia and Thailand.
Still, HSBC said the long-term environment remained supportive for Asian equity markets, so a decline should be seen as a buying opportunity.