What matters more - inflation or growth?
Whether rising yields are good or bad for equities may also depend on what is driving the move up - is it inflation or is it a rise in real yields reflecting higher potential growth in the economy?
Between 2001 and the end of 2007, equities had a positive correlation with both components with the magnitude similar in size. Over this period, the biggest driver in bond yields was the movement in the real rate associated with changes in the potential growth of the economy.
Generally higher potential growth is associated with higher inflation - certainly that was the case prior to the Global Financial Crisis (GFC). If long-term earnings growth tracks nominal GDP growth, then a gradual rise in yields associated with higher growth and inflation may not be bad for equities.
In the 10 years since the GFC however, the correlation with the real yield turned negative (Chart 3) and the magnitude of the correlation with inflation doubled. In the "lower for longer" post GFC environment, higher growth has not been associated with higher inflation. In this environment, a rise in interest rates associated with a rise in potential growth compresses corporate margins given the absence of pricing power.
In the post crisis environment, what matters most are signs that the economy is healing. This is evidenced best by a rise in inflation. Higher inflation suggests central banks have been successful in steering their economies out of the post-GFC-induced deflation funk. The rise in strength of the correlation between equities and inflation possibly reflects how important inflation and pricing power is to corporate earnings.
So rising yields may not necessarily be all that bad for equities providing that the level remains relatively low and the move up is driven more by inflation than real growth. Intuitively, the best type of inflation for equities is demand-pull as cost-push inflation tends to be absorbed in profit margins.