Why falling bond prices are traditionally seen as bad for stocks

  • Many investors are wary of the interplay between the two different asset classes, and many argue that rising yields could be detrimental to stocks in the longer term
  • On this basis, investors would likely change their investments and remove money from stock markets
Traders work on the floor of the New York Stock Exchange (NYSE) in New York, U.S., on Monday, Aug. 21, 2017.

A sharp sell-off in bond markets this week spilled over into global equities with jitters that a near 30-year run bull run for fixed income could be coming to an end.

Many investors are wary of the interplay between the two different asset classes, and many argue that rising yields (when bond prices fall as yields have an inverse relationship to prices) could be detrimental to stocks in the longer term.

End of the cycle?

"Traditionally (higher yields) are not good for equities, because it indicates that the economic cycle is maturing and thus a downturn may be on the horizon," Lothar Mentel, chief executive officer of Tatton Investment Management, told CNBC via email.

Longer-dated bond yields — like the rate on the U.S. 10-year Treasury — help set prices for a range of mortgages and loans all over the country. If they surge higher it shows that the market is expecting inflation to pick up. This can be a sign of a healthy economy, but some analysts warn that there is a limit to this. Surging inflation can cause central banks to lower interest rates and can raise questions on when the next recession will hit.

On this basis, investors would likely change their investments and remove money from stock markets.

"If yields are rising, the economy is overheating and therefore getting nearer to off the cycle," Bill Blain, strategist and head of capital markets at Mint Partners, told CNBC via email.

Corporates paying more

Another concern is that large companies will pay more to borrow money in the coming years as yields rise higher. And it will also boost the money they are spending on services their current debts. This could affect their earnings and could also affect how much they will be able to pay to shareholders, if anything at all.

For equity investors, higher yields can be a signal that they may see fewer returns in the future compared to original estimates. Bill Blain at Mint Partners adds that there's a risk that "the economy will contract."

No reason to worry?

However, just like in pretty much any economic concept, there are those who interpret higher yields in a different way.

Steve Blitz, chief U.S. economist at TS Lombard, told CNBC Wednesday: "Rising yields, if they are accompanied by an accelerating economy, an accelerating income and stronger employment, they are not necessarily going to cut off mortgages and cut off growth."

In his eyes, as long as the economy keeps growing, companies will have money to pay their employees and invest. Thus, the stock market shouldn't necessarily worry too much with how yields are moving.