Turn off CNBC and Watch Real Yields

Advisor Perspectives welcomes guest contributions. The views presented here do not necessarily represent those of Advisor Perspectives.

Investors watch CNBC and other media outlets for guidance on where the markets are going. CNBC may provide insightful commentary from very qualified investors, but if one is watching CNBC to figure out where markets are headed, they will be better served looking to the bond market for direction.

Real yields, or the bond yield less inflation expectations, explain the movement of many assets. If we are to form reasonable expectations for stocks, commodities, the dollar index, and gold prices, we best have an opinion on where real yields are going.

I share evidence supporting the recent strong relationship between real yields and risk assets. I then ponder where real yields are heading to help save you the confusion of trying to follow the conflicting bullish and bearish views presented on CNBC.

What are real yields?

The real yield is the yield an investor expects to receive after inflation. Think of it as the amount of purchasing power a bondholder expects to gain or lose. The inflation figure within the calculation is based on inflation expectations which are a byproduct of the difference between TIPS and nominal yields.

In a free market, lenders should be compensated for lending money. The compensation in the form of interest rate should encompass the risk of non-repayment, the opportunity cost of not having the money available, and expected inflation.