February 16, 2018 / 4:27 PM / in 8 months

After weeks in lockstep, stocks and bonds go their separate ways

LONDON (Reuters) - Global stocks seem to have finally stopped worrying about their bond market cousins.

A man walks past an electronic stock quotation board outside a brokerage in Tokyo, Japan, February 9, 2018. REUTERS/Toru Hanai

The last few weeks’ turbulence on world equity markets was triggered largely by a slide in U.S. Treasuries that saw 10-year borrowing costs surge towards 3 percent for the first time in four years.

And until this week, wherever bonds went, equity was sure to follow.

But when bond market angst went up another notch following forecast-topping U.S. inflation data, stocks suddenly ignored their fixed-income counterparts and staged an extraordinary comeback, bringing them back into the black for the year.

In fact, MSCI’s main gauge of world stocks was set on Friday to post its best weekly performance since late 2011. .MIWD00000PUS

Rising bond yields typically price in rising inflation and, ultimately, interest rates. And a rising interest rate environment is often assumed to be negative for stocks, as higher borrowing costs slow the economy and earnings growth and tempt portfolio managers to switch back to bonds from equity.

But economists argue that historically, stocks and bond yields have often moved in tandem and that this is typical in a fast-growing economy. Higher growth and inflation keep investors wary of fixed income, support consumption by eroding household debt in real terms and increase corporate pricing power and margins.

Here are three charts that may shed light on recent market moves:

1) BONDS FROM MARS, STOCKS FROM VENUS

After hitting record highs, world stocks sold off on Feb. 2, following higher than expected wage data in the United States.

The data stoked fears of a wage-driven pickup in inflation, which led to a selloff lasting for a week. This week however, stocks rebounded strongly in tandem with a rise in bond yields.

Stocks shrug off inflation fears - reut.rs/2o4zusm

2) THE LONG VIEW

As the following graphic shows, since the late 1990s, stocks and bonds have tended to move in lockstep over the long-term, particularly during periods of economic growth.

The long view: stocks vs. bonds - reut.rs/2o2J7rk

3) EQUITY RISK PREMIUM FADES

Equity risk premium is a measure of the extent to which investors are compensated for investing in equities versus bonds. It is calculated by taking the difference between the earnings yield (inverse of the P/E ratio) of a stock or stock index, and a bond yield. The size of the difference indicates how much more they are being compensated for taking on the additional risk of investing in stocks. The recent climb in bond yields has eaten away at this premium, thus making stocks less desirable versus bonds.

Rising bond yields erode equity risk premium - reut.rs/2C3V0pN

Reporting by Ritvik Carvalho; Editing by Hugh Lawson

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