Simply speaking, rising bond yields are bad news for the Australian sharemarket. The local bourse is laden with bond proxy stocks that in recent years have benefited from yields near record lows.
The seemingly endless prospect of monetary stimulus from central banks sent bond yields in parts of Europe and Japan to negative territory creating a wave of bond refugees into the sharemarket.
![Telstra shares hit a two-year low earlier this month as bond yields surged on the expectation of higher interest rates.](/web/20170104135415im_/http://www.watoday.com.au/content/dam/images/g/r/y/z/j/l/image.related.articleLeadwide.620x349.gsr8kd.png/1479468232719.jpg)
It created a boom time for stocks with lower risk profiles. Real estate investment trusts (REITs), infrastructure, utilities, telcos and financials traded at lofty premiums to the market.
In the past three years, the financials, REITs and utilities sectors more than doubled not on company performance, but on central bank stimulus, Schroeders head of Australian equities Martin Conlon said.
But the rally could never last.
Bond yields set to rise further
"Bond yields are rising as policymakers, acknowledging that monetary policy has reached its limits, are turning to fiscal policy to prod economies," Mr Conlon said.
Australian 10-year government bond yields have risen 80 per cent since August and they have further to go. While the spectacular surge in global bond yields since the election of populist Donald Trump, who bought with him the promise of aggressive fiscal stimulus translating to higher inflation and interest rates, has eased, the longer-term trend pointing to a decline in bonds is intact.
![](http://web.archive.org./web/20170104135415im_/http://www.smh.com.au/cqstatic/12z7v7/1911_10yr-Aus-yields3_729.jpg)
The ASX is particularly vulnerable as about 60 per cent of the top 200 stocks are sensitive to rising yields, Mr Conlon said.
"The worry for yield plays is that the rise in global bond yields looks entrenched. Be prepared for turbulence if yields rise faster and by more than expected."
Utilities, infrastructure stocks and REITs were more vulnerable, he said, because management used low interest rates to borrow heavily, sometimes to pay dividends. Banks are likely to come under pressure not from lower margins on higher interest rates, but rising bad debts, the cycle of which appears to have bottomed.
Since August, Transurban shares have lost 14 per cent, while Telstra has fallen 17 per cent and touched a two-year low earlier this month.
Not all bad news
But, according to history, the drag from bonds on shares should diminish, Credit Suisse equity strategist Hasan Tevfik said. Those most vulnerable to further eruptions in the bond market are companies trading on high price-to-earnings ratios, high financial leverage and high payout ratios.
"They are most vulnerable to higher bond yields and include Sydney Airport, APA, Healthscope, ASX and BWP Trust," he said.
Other parts of the market should weather the storm. Cyclicals, including mining and energy stocks, are benefiting from the savage cost-cutting programs they implemented as commodities bottomed, and are now enjoying the resurgence in prices.
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