Higher Bond Yields 'Overhang' for Equities, Chronert Says

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00:00Equities down this morning by about a third of 1%.

00:02This is The View on Wall Street from Scott Croner, The City, writing the following.

00:05Recent signs of consumer slowing are concerning.

00:08We bias in favour of a combination of defensive names and secular growers

00:12that have been more heavily investing in their businesses.

00:15Scott joins us now for more.

00:16Scott, welcome to the programme, sir.

00:18We need to take a bit of a beat and talk about what's developing in the bond market

00:20and what ultimately it means to you and the team in equities, Scott.

00:24What happens when we get to these kind of levels in bonds?

00:27What does it mean to you?

00:27Jonathan, well, it means a couple of things.

00:31I think first and foremost, you look at the potential impact of higher rates

00:35in terms of a slowing effect and in terms of demand for new credit.

00:38That's pretty straightforward.

00:40Additionally, from an equity perspective, it's mostly about valuations.

00:45And essentially, when you're looking at how to value securities,

00:48it's a combination of where you think near-term fundamentals are going,

00:52but it's also how you discount future earnings 5, 10 years down the road

00:57and assign a valuation to terminal values.

01:02And so what ends up happening here is when you back up yields,

01:04you begin to change the math, and those future earnings are worth less now.

01:09So the bottom line is that from a valuation impact,

01:12when you look at this current trajectory in 10 years in particular,

01:17where we focus, it's a gating factor potentially on future economic activity,

01:22but essentially real-time, it's an overhang in terms of the valuation set up for U.S. equities.

01:28When you look at the policy down in Washington, Scott,

01:31we do have the one big beautiful bill passing through on the House side,

01:34and the bond market seems to be pushing back on a number of issues.

01:37But what if they didn't do anything,

01:38and we would have a tax hike at the end of the year?

01:41What would the bond market do then?

01:43It's kind of pick your poison, right?

01:45So what you would get with the tax hike, which was where we were a year ago at this time,

01:49looking at potential presidential election outcomes,

01:52is that you would have a different influence

01:55where you would probably begin to slow aggregate spending levels.

01:58You would crowd out essentially expenditures

02:01because more of your income is going to taxation.

02:06So essentially, it's to be careful what you wish for.

02:08The bottom line, Emery, is that we've been living in

02:11a fairly fiscally stimulative environment going back to the pandemic.

02:16That's when you really began to see your debt-to-GDP rise.

02:19And now with the Fed rate policy in the rearview mirror,

02:23you're also looking at the debt service component kicking as well.

02:27So essentially, from my perch, from an equity perspective,

02:31you get the deficit spending.

02:32That's fiscally stimulative.

02:34That's actually pretty good for economic activity

02:36and probably for corporate fundamentals.

02:38But the offset is what you're doing in terms of paying forward now

02:43for future pain in terms of the risk of higher for longer rates,

02:48the valuation impact, and the ultimate slowing effect

02:51that can have on economic activity.

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