Preface
This post has notes on bond yield and dividend yield. And then concludes by wondering what should happen to the market?
Bond Yield
The year-on-year US inflation rate, which is currently at 7%, is at a multi-decade high. If you refer to this chart, the YOY inflation rate (blue) has been rising for more than a year now. As an effect, 3Y (yellow) and 10Y (green) bond yields have begun rising from their lows.
US Fed is indicating the possibility of raising interest rates to counter inflation.
“Powell indicated a willingness to raise interest rates and unwind other pandemic-era economic support programs as the central bank contends with rising inflation…”
Here in India, bonds yields have been rising too:
Dividend Yield
The dividend yield is the amount paid out as a dividend divided by the share price. Hence,
Dividend yield = dividend amount/share price
Note the following:
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Usually corporates do not (like to) change or reduce dividends amount paid YOY. Look at the history of some rich dividend-paying stocks
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Raising bond yield (or, interest rate) has a direct impact on the dividend yield. This is because investors (read institutional) find better alternative yields at lower risk
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In this post’s context, interest rate and bond yield are interchangeable. That is, while these two are inversely related, an increase in either may lead to a decrease in asset prices
So, what happens when bond/interest yield rise?
As of 14-01-22 :
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NIFTY 50’s dividend yield is at 1.12% (Source: NSE)
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364 day T-bills (G-Sec) yield is at 4.38% (Source: RBI, under Current Rates).
We deduce NIFTY 50’s dividend amount per unit as (as of 14-01-22):
Dividend amount = dividend yield * share price
Dividend amount = 1.12% * 18255.75 = Rs. 204.5
Now assume that either the bond yield or interest rate increases by, say, 1%. Then theoretically, the market will demand dividend yield to also increase by 1% to compensate investors to stay “invested”.
So, we have:
Dividend amount = 204.5
New dividend yield = 1.12 + 1 = 2.12%
Therefore,
NIFTY 50 price = dividend amount / new dividend yield
NIFTY 50 price = 204.5 / 2.12% = 9646 [See Note 1 above]
Therefore, in order to compensate for a 1% rise in interest/bond yield, NIFTY 50 should descend to 9646. That is, a decline of -47.2%! Similarly, for a 0.5% rise in interest/bond, NIFTY should decline to 12,623 to remain attractive.
Market view
In a scenario where bond yield rises, it is not given that markets would follow and start correcting immediately. Often because markets are forward-looking, and behave irrationally from time to time.
However, it is given that:
- Market is a slave of corporate earnings
- Bubbles always pop
As of today, various NSE sectors (on monthly basis) are in a definite uptrend and valuations are rich. Technical indicators do not show any imminent correction. So, do you think correction would be sudden? 
Smart investors always prepare to exit. Retail investors look forward to entering.
Best,
Vijay Zanvar