Worthy Articles: Why Bond Yields are a Triple Sextuple Threat

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Why Bond Yields are a Triple Sextuple Threat

via The Big Picture by ritholtz on Jun 13, 2007

Last night, Larry asked me which was a bigger threat to stocks, a US/Iran conflict -- or rising bond yields.

The correct answer was, of course, rising yields.

I described it as a triple threat -- but it may be even more than that; it could be a quadruple or quintuple or even sextuple threat!

Why? consider:

1) Valuation: Models such as the so-called Fed model that have been declaring equities undervalued rely on comparing the earnings yield with the 10 Year yield. As the yield spikes, what was "undervalued" by this measure suddenly is much less so.

2) The M&A / LBO Put: One of the firm bids supporting this market has been the manic pace at which public companies have been taken private of by Private Equity (soon to be public themselves). Some have argued this was based on cheap stock prices, but we shall soon find out that it was based in fact on cheap money. As that gores away, so too will the LBO Put.

3) Competition: If you could get a guaranteed 5.5% or 6% on your money -- risk free -- would you? The answer depends on your personal situation, but for many institutions and wealthy investors, the answer is absolutely.

4) Profits: If it costs more to borrow or finance, that bites into profits. Indeed, this has been one of the primary complaints about the Fed model, it double counts low rates this way, and can makes apparently cheap looking companies more expensive-looking in fast order as rates rise.

5) Share buybacks: Much of the share buybacks we have seen have been financed with cheap borrowed money. This is another leg of the bullish stool that is about to leave town on the same stagecoach as low rates. (cue music, sunset)

6) Consumer spending: WIth MEW sliding, we have seen an increase in consumer credit driven spending. Watch that crimp if rates stay near 5.25%. Indeed, we could see a move towards 5.5% by Summer's end once people realize Bernanke is serious about a rate hike by year's end.

We have PPI and CPI out later this week, so this may all be moot by the weekend.

But with inflation over 3.4% in China, I somehow doubt that . . .

Sources:
Oh, Yeah -- Inflation
David Gaffen
Maretbeat, June 12, 2007, 4:35 pm
http://blogs.wsj.com/marketbeat/2007/06/12/four-at-four-oh-yeah-inflation/

Chinese Inflation Fuels Few Worries So Far
By ANDREW BATSON
WSJ, June 13, 2007; Page A2
http://online.wsj.com/article/SB118162534329732351.html