How bond yields affect stock market
1.Bond yields are the important key to calculating opportunity cost of equities.
Bond yields, represent the opportunity cost of investing in equities. For example, if the 12 year bond is yielding 8% per annum then the equity markets will be attractive only if it can earn well above 8%. In fact, equity being risky there will have to be a risk premium, first of all, to be even comparable. Let us assume that the risk premium on equities is 5%. Therefore that 12% will literally act as the opportunity cost for equity. Below 12%, it does not make sense for the investor to take the risk of investing in equities as even the additional risk is not being compensated. The question of wealth creation only begins after that. As bond yields go up the opportunity cost of investing in equities goes up and therefore equities become less attractive. That is the first reason that explains the negative relationship between bond yields and equity markets.
