InvestorQ : What is the relation between bond rates and the stock market makes new highs?
Dhwani Mehta made post

What is the relation between bond rates and the stock market makes new highs?

Answer
image
Archita Jajjoo answered.
2 weeks ago
Follow
Stocks and bonds by themselves aren’t directly correlated in any way. It is just the underlying triggers that could make them move in a coordinated manner. Having said that, I think the problem is reversed. As yields start hardening, stock markets tend to show a decline.

This could be due to various reasons. Some of which I have explained below-

Rising interest rates: A rise in bond yields denotes higher interest rates in the economy. Higher interest rates push up the cost of companies' loans and make it harder for them to borrow additional money to invest. This ultimately affects their profits and hence the returns of shareholders. The stocks of companies with a large amount of debt are particularly impacted. People who rely heavily on credit may also cut back, which could have a ripple effect on all kinds of companies that rely on consumer spending. This reduces the overall demand in the economy. 

Cash flow corrections: A stock is valued as the discounted sum of its cash flows. There are two components to this concept. First, a sum of cash flows. For example, if the company is expected to generate Rs1 crore every year for the next 25 years and zero thereafter, the value of the stock would be Rs25 crore. However, Rs1 crore after three years is worth less than Rs1 crore today because of inflation. This is even more true of Rs1 crore after five years or ten years. Hence, equity analysts apply what is called a ‘discount rate’ to the cash flows, assigning lower values to cash flows that are further and further in the future. This discount rate is the risk-free interest rate in the economy. When the risk-free interest rate rises, the value assigned to cash flows drops. Rising bond yields imply a rise in the risk-free rate and hence lower equity valuations.
4 Views