Royal Dutch Shell PLC, Standard Chartered and Crest Nicholson PLC are among the companies that could do best as bond yields continue to rise, according to analysis by investment banks.
As almost all analysts agree, low bond yields have been a key support for equity markets since the 2008-09 global financial crisis, but those at UBS noted that though European equities have historically had a positive correlation with US bond yields (though not necessarily real bond yields, which take inflation into account).
Bond yields are rising and are expected to continue to ruse over the coming six to 12 months as the global continues to (stutteringly) recover from the pandemic, inflation rates climb, central banks taper their bond-buying and begin to nudge interest rates higher.
The 10-year US Treasury yield topped 1.5% this week and the UK 10-year Gilt hit 0.95%, a level that it has not sustained since May 2019.
Economists at UBS forecast 1.80% for US 10-year yields at year-end, which equity strategist Nick Nelson says is likely to be a “manageable pace for equities”. Those at Berenberg foresee the US 10-year bond yields breaking 2% and UK 10-year gilt yields hitting 1.5% in 2022.
A transition to a period of higher inflation, rising bond yields and rising interest rates will present new challenges for equity markets, but with UK equities benefiting from a generous earnings yield gap “cushion” above risk-free rates, Berenberg equity analyst Jonathan Stubbs said if earnings keep growing and if the move to higher bond yields is “orderly” this “should still allow UK share prices to make progress higher over the coming six to 12 months”.
He noted that bond yield correlations suggest a “tailwind to UK equity sectors such as banks, energy, and consumer products services”, but “a headwind to UK sectors such as healthcare, food and beverage, and drug and grocery”.
Berenberg has run various strategy screens, of which two incorporate a skew to rising bond yields.
The “value+” strategy looks for stocks with a combination of strong fundamentals and attractive valuations with a positive correlation to bond yields, and features Shell, StanChart, Crest Nicholson, Elementis PLC, WPP PLC, Stagecoach Group PLC, Old Mutual Limited, TBC Bank, Bank Of Georgia Group PLC and S&U PLC.
The other, the “bond yield beta” strategy combines positive correlation with bond yields with support from earnings momentum and growth, which attempts to look for UK companies likely to benefit from rising UK 10-year bond yields combined with a positive fundamental outlook. The stocks that feature in the large-cap screen are Mondi PLC, Meggitt PLC, DS Smith PLC, Hays PLC, Johnson Matthey PLC, Marks and Spencer Group PLC, Vesuvius PLC, Tullow Oil PLC and John Menzies.