Bond yield & bull run

Equity investors will do well to take note of the movement & returns of other financial instruments. One good example is the bond market. It is one of the favourite destination for investors due to the following reasons:
1) consistent, stable long term returns
2) much less volatility (good for risk-averse investors)

The yield on the 4.5 percent security due May 2017 now trades at 5.18 percent. Last Thursday and Friday were the first time since August 2006 it had breached the key 5 percent threshold. This is one major indicator to start worrying about the present bull run.

How Bonds Affect Stocks
Why do bonds matter so much? Rising bond yields put pressure on the economy, by making all kinds of debt more expensive, including home mortgages and corporate loans. At the same time, higher yields make bonds more attractive to investors and thus make stocks relatively less attractive.

Just as important, if the debt markets run into difficulties, that could bring to a halt the rash of mergers that have been running at record levels and have been a key underpinning to the stock market. Higher rates drive up the costs of the heavy borrowing that leveraged-buyout specialists rely on to finance takeovers.

One factor in the bond-market woes: concern about inflation, or rising prices. Inflation eats away at the value of bonds, as interest payments that are a fixed number of dollars can buy fewer and fewer goods and services. Now, more economists are suggesting that inflation could be a growing problem, as global workers, even in China and India, begin pushing for higher wages. Foreign central banks also are pushing rates higher, amid strong economic growth around the globe.

In some ways, yields on U.S. bonds are simply keeping up with global bonds -- yields on European and Japanese bonds all have moved up in the last month. In the past, the fact that U.S. inflation is still running at a tame rate of about 2% might not have forced up U.S. bond yields. But the U.S. imports more than it exports and it has to borrow funds from abroad to pay for the difference. So yields on U.S. bonds must stay competitive with those abroad to keep attracting foreign investors.

The ECB also just recently raised rates thus putting a whole round of higher rates expectations which should start to work its way into global equities. Rates ARE headed higher in the UK, euro zone and Japan. The US will have to follow or see a major selldown in the dollar. Risk-reward ratio for equity investments is not that attractive now. Investors should stay away from expensive shares and companies with plenty of hot air (nice story but no substance).