The Importance Of Equity Duration

By Variant Perception

We have seen much commentary that if US 10y yields go back to 2.5% or 3.0%, then equity markets suffer.  We prefer a different way to looking at the problem.  The key is what inflation is doing alongside any move in nominal yields. The below chart shows the % of the US yield curve trading below inflation. We highlight in green the periods when more than 50% of the yield curve is trading below inflation (as is the case today).

Typically, negative real yields are very stimulative for equities.  It is only when most of the yield curve is trading above inflation (white bars in right chart above) that equity markets start to face persistent headwinds.

Equity investors do need to worry about rising yields in terms of sector rotation.  Duration is a basic concept for fixed income investors, but for equity investors, it is a less common method to look at portfolio exposures.

We have built a duration calculator for equities, using a combination of a 15-year DCF (consensus earnings forecasts, 2% terminal growth rate, individual cost of equity) and a terminal value duration component. This allows us to see which equities are most sensitive to a move in yields.

For the stocks in the Russell 1000, we calculate the duration of each name and aggregate to find the duration for different sectors. Financials, energy and consumer staples look like relative safe-havens. Info tech, healthcare and consumer discretionaries have the highest durations and are more vulnerable to yield moves.