If Bond Yields Are Telling One Story And Equities Another, Whom Do You Believe?

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Bond yields have been rising for the last couple of months while equities have been rising at a steady pace. This dichotomy is because the factors weighing down on the bond market are likely doing the exact opposite for equities.For now, there is no telling how long the ongoing rout in the bond market will continue. As bond prices kept sliding, yields have risen by 50-60 basis points in less than two months.

On the other hand, the benchmark Sensex and Nifty indices have risen by around 1.5 percent each over the same period. In fact, as on Thursday, which was the day of expiry of December futures and options contracts, the Nifty had gained 2.5 percent since the expiry of the last series.

Rising bond yields seem to be telling a story, one of risks to fiscal deficit and inflation. The equity market, on the other hand, has a story of its own--one of a pickup in earnings in 2018 and steady inflows into equities. And the confusion seems to be about whom to believe.

If the bond market is factoring in a risk to inflation, equities should ideally reflect it since inflation is bad for equity investors. Rising inflation gives makes a case for hiking rates, which would in turn increase companies’ cost of borrowing. Higher inflation would also mean companies would be spending more on raw material. But the equity market seems to be ignoring this completely, because it is factoring in a possible uptick in earnings in the coming few quarters.

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