Share and Bond Markets Decouple Amid Rising Inflation and Bond Yields

The Australian share and bond markets have had a tumultuous ride in recent months, with both suffering significant losses. However, unlike in the past, the two markets have not fallen in tandem, leading some to wonder what is driving this divergence. According to Paul Dyer, an asset allocation specialist at Potter Warburg, the share market has "de-coupled" from the bond market, with the latter bearing the brunt of the losses.

Key Takeaways:

• The Australian share and bond markets have fallen by one-fifth and one-third, respectively, since late January.
• The 10-year bond is priced on inflation expectations, and the market believes inflation will rise, requiring a higher nominal rate.
• Share investors are concerned about the share market's performance, wanting it to "de-couple" from the bond market and march to its own drum, driven by economic growth.
• Paul Dyer believes that de-coupling has occurred to some extent because the share market has not performed as badly as it could have, despite bond yields doubling since 1994.
• Real yields have not risen to the same extent as nominal yields, providing some protection to the share market.
• The divergence between the two markets may be due to the share market's inherent inflation-hedging properties, representing a real asset, whereas bonds have none.
• Investors face a conundrum: strong economic growth, while beneficial for shares, also puts pressure on inflation and interest rates.

Statistics:

• Since late January, bond prices have fallen by over one-third.
• The all ordinaries index has fallen by one-fifth since late January.
• Bond yields have gone close to doubling since the 1994 turning point.
• Real yields have not risen to the same extent as nominal yields.

Sources:

• "Byline: James Dunn When shares are up, bonds are down, right?"
• "Tom Blunt"