By Eric Bush, CFA, Gavekal Capital Blog
Considering that only 57% of developed market government bonds have a positive yield, it can be difficult to believe that rates can go lower. However, then you realize Switzerland's entire yield curve from 3M-30Y is negative, and Japan is talking up further QE utilizing "helicopter money," and it is easy to believe anything is possible. If lower rates are in the cards, and if the past decade is any guide, then for equity investors, it will pay to be overweight US equities relative to the rest of the developed world.
Since 2005, two of the strongest relationships for relative equity performance have been the German 10-year bond yield and the Japanese 10-year bond yield. The correlation between the relative performance of US equities to the GKCI DM Index and the Germany 10-year bond yield has been a very strong -92% since 2005 (i.e., yields move lower, US outperforms). Similarly, the correlation to the Japanese 10-year bond yield has been -91%. The correlations to US yields have been strong, but not nearly as much. There has been a -70% correlation to the US 10-year bond yield and a -80% correlation to US 30-year bond yield. Conversely, if rates begin to rise in earnest, then European equities probably begin to outperform. Lower rates have been tied to major underperformance in France, Italy and the UK. It seems reasonable that if rates moved higher, these stocks would benefit the most.