WWRR Vol.2.015

2019 Global Economic and Market Outlook
would see equities move higher as bond yields pushed up towards 3.75%. However, this ignores
the imprecision in the fitted values and the ever-important developments in earnings.
Fig 36 Fed model proponents typically highlight the 1960-
2010 period as evidence of the model’s validity
The Fed Model in Practice
Per cent
20
S&P 500
10-year nominal
18
earnings yield
government bond
yield
16
14
12
10
8
6
4
2
Fed model a good
descriptive tool
0
1871 1891 1911 1931 1951 1971 1991 2011
Source: Macrobond, Macquarie Macro Strategy
Fig 37 Adherence to the Fed model would be consistent with
further declines in the earnings yield (increases in prices)
Fitting the Fed Model*
Per cent
16
Actual S&P 500
earnings yield
14
Fitted earnings yield
12
(1960-2010)
10
8
6
4
2
*Includes the 10-year yield and a constant,
regressed over the specified period
0
60 65 70 75 80 85 90 95 00 05 10 15
Source: Macrobond, Macquarie Macro Strategy
Fitted earnings yield
(1980-2010)
Historical correlation
Given the recent attention that has been devoted to historical stock-bond correlations, the related
stylised facts are now well-known: prior to 1965, the correlation varied, but broadly averaged zero;
between 1965 and 2000, the correlation was usually strongly negative; and since 2000, the
correlation has typically been positive. This suggests that, should the last two decades be any
guide, the equity bull market should remain in-tact even as yields push higher.
However, given the propensity for structural breaks in this relationship, many have begun to point
to shorter-term correlations to suggest that a structural shift is imminent. While this approach may
indeed permit a more timely assessment of the changing relationship, it has also produced false
signals in recent years. Moreover, rather than the short-term correlation deteriorating, it has
actually ticked up recently, after being broadly stable (and slightly positive) since early 2018.
Fig 38 The historical relationship between equities and
bond yields has changed through time
Index
0.8
0.6
0.4
0.2
0.0
-0.2
-0.4
-0.6
US Equities and Bond Yields*
36-month rolling correlation
*Dashed grey lines indicate period averages
-0.8
1871 1891 1911 1931 1951 1971 1991 2011
Source: Macrobond, Macquarie Macro Strategy.
Fig 39 Even at shorter time horizons, the relationship has
moved around dramatically, and has ticked up recently
Index
0.8
0.7
0.6
0.5
0.4
0.3
0.2
0.1
0.0
US Equities and Bond Yields
-0.1
52-week rolling
-0.2
correlation (LHS)
-0.3
*Dashed lines indicate Macquarie forecasts
00 02 04 06 08 10 12 14 16 18
Source: Macrobond, Macquarie Macro Strategy
52-week change
in 10-year yield
(inverted, RHS)*
Bps
-250
-200
-150
-100
-50
0
50
100
150
200
250
300
Many have also argued for the presence of “threshold effects” i.e. equities will trend upwards
provided yields remain below some level, but will break down otherwise. Although psychological
levels could be important, we do not see compelling evidence of threshold effects historically.
Perhaps more relevant is the rate at which yields are rising. Indeed, in recent times there has been
an inverse relationship between the equity-bond correlation and changes in yields, suggesting that
equities could decline if yields increase too rapidly.
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