Here, recent history is clear. Rising bond yields have generally been good for shares. Since January 2000, the correlation between annual changes in 10-year US Treasury yields and in the All-Share index has been hugely positive, at 0.64. Rising yields in 2004, 2006 and 2010 were all accompanied by rising share prices.
Granted, there's a caveat here. Steepenings in the US yield curve - a rising gap between long- and short-dated bonds - have been associated with falling share prices. But this is because the yield curve often steepens in recessions as the Fed cuts interest rates, and recessions are bad for shares. 'Bear steepenings' in the yield curve - where short- and long-term rates both rise - have generally been good for the stock market.
There's a simple reason for this. The circumstances in which bond yields rise as ones in which investors look forward to a stronger economy and want to take on more risk. These are great times for shares. The stock market rarely falls much in anticipation of the Fed raising interest rates, because it only does so if the economy is strengthening, and this good news mitigates the bad news of an impending monetary tightening.
The picture, then, seems clear. Equity investors have nothing to fear from a bursting of the bond bubble (if indeed that is what it is). This poses the question: how could such a burst hurt shares? There are three possible mechanisms.
One is inflation. An unexpected rise in this - if markets expect it to persist - would be bad for bonds. And it would hurt shares too if investors expect the Fed and Bank of England to tolerate weaker growth in order to bring it down.
Right now, though, this seems a distant risk. Even if inflation does rise, the Bank and Fed might well regard it as a price worth paying for boosting economic growth. That's bad for bonds, but not so much equities.
A second possibility would be a rise in demand for liquid assets or for shorter-duration ones. This would entail investors dumping bonds for cash and selling shares too, as these are also long-duration assets.
This seems an abstruse possibility. But it was quite common in the 1980s and 90s, because bond and share prices then often fell together. The strong negative correlation between equity and bond returns is largely a phenomenon of recent years. However, with cash returns negative in real terms, it's hard to see what would trigger an increase in liquidity preference.
A third possibility is that a sustained sell-off in bonds might create increased uncertainty, and the cliche that equity investors hate uncertainty is correct. For example, if investors fear that the global savings glut that has forced yields down in recent years is abating, they might suspect the world economy is entering a new paradigm. This would happen if, say, China rebalances its economy away from exports and towards consumer spending. This could initially be bad for equities simply because it would betoken that the world economy is moving into uncharted waters.
We can, therefore, tell stories in which a bursting of the bond bubble would hurt shares. But in such stories, gold could well do well - not just because investors would fear inflation but because gold is a hedge against uncertainty.
In this sense, an investor with a balanced portfolio of equities, gold and cash has little to fear from rising bond yields. In fact, many of us have much to hope from them, as rising yields mean rising annuity rates and so a more prosperous retirement. Of course, we cannot tell when, if, or by how much bond yields will rise - although my hunch is that they will. But there are some things many of us don't need to know.
