Luminor: the increase in the US 10-year bond rate above 3% is not clearly bad news for equity markets

“The interest rate movements became one of the main topics for discussion, setting the direction in equity markets and attracting more attention than corporate earnings reports,” explains Atis Krumins (Atis Krūmiņš), Head of Luminor Investment Management division. “Particular attention was drawn to the brief movement of the yield on the US 10-year government bonds over 3%, which actually spooked investors by intensifying volatility in the equity market. The main reason for such investors’ reaction were the concerns that higher interest rates may hamper overall corporate earnings, while also making bonds relatively more attractive for investment compared to equities.”

Recalling the end of the low interest rate period, this was the first time in the last 4 years when the yield on US 10-year bonds exceeded the 3% level. However, the average yield on US 10-year bonds has been 3.5% since 2000 and 4.6% in 1990. Higher interest rates actually mean the market expects robust economic growth and moderate inflation, which is usually a stimulating environment for equities. Historically, none of the four times that the yield on the US 10-year bonds crossed 3% provided negative equities market performance in either 1 or 3 year horizon

In April, European markets showed good results, providing an almost 4.5% increase. The equity markets of the developed countries were also generally successful with a 4.2% increase, while emerging market equities remained unchanged over this period, with minor losses YTD, at -1.3% since the beginning of the year. The All Country World Index (ACWI) has managed to recover the loos and remains unchanged for the near future.

More on the current trends in Luminor latest financial market overview: May 2018

Recent data show US companies' Q1 earnings to have increased by 25% compared to the year before. Moreover, 80% of the companies reporting outperformed the analysts’ forecasts. Significantly, the earnings of the companies increased not only as a result of the favorable tax reform but also because of an increase in sales – by 8.4% year on year. This indicates that the global economy is strong and that earnings’ growth could continue.

All the prerequisites for the continuation of the equity uptrend are still intact: global economy is growing, monetary policy still fairly accommodative, inflation is proportionate and corporate earnings are growing. Moreover, the exceptional optimism that appeared in the beginning of the year has disappeared due to the latest price correction. Although the increased volatility may still continue for some time, the upward trend in equity markets seems to remain valid in the long term perspective.

The most significant financial market trends of the past month:

• Global equity markets have managed to partly recover from the loss of the beginning of the year and, on an annual basis, the prices have not changed significantly.
• For the first time in over four years the yield on the US 10-year government bonds crossed the 3% level, which, according to the historic average, should be followed by a positive US equity market performance over the next year and the upcoming three years.
• Although interest rates have increased, equities still maintain a risk premium, which is for 3% higher than that of the bonds.
• The US yield curve has been flattening, as a result of which the difference between the yields on 10 and 2-year bonds has fallen to around 0.5%. Also historically, in most of these cases, a positive performance can be observed in the US equity market over the next year and in a three year perspective.
• US companies report very good results, and almost 80% of the companies outperform analysts' expectations, which were already initially optimistic. The corporate earnings are projected to increase by more than 25%.

Contacts for media

Signe Lonerte
Head of Marketing and Communications at Luminor 
+371 2911 6146
Signe.Lonerte@luminorgroup.com