The recent rise in bond yields should be a warning signal for equity investors, suggests UBS Securities Canada Inc.

“The rise in bond yields has now been sufficient to flash caution signals for equity markets in the months ahead,” it notes.

“Specifically, the recent jump to 4.75% in the U.S. 10-year yield has pushed its cumulative rise to about 75 bps from its lows during this episode of Fed tightening. This compares to the just over 100 bp rise that has typically preceded peaks in equity markets over the last 25 years.”

“In addition, market peaks have occurred at steadily lower levels of real 10-year yields over the years,” it adds. “Indeed, the present 2.65% real 10-year yield (using core CPI) is not far from the 3.1% level that prevailed prior to the 2000 peak. In addition, the real Fed Funds rate (also at 2.65% assuming a hike on Mar 28) has moved to the middle of the range that has preceded equity market peaks.”

It adds that there are other reasons to be wary of stocks. “The yellow light from rates and yields is in addition to our valuations that show the TSX about 9% above our estimate of fair value, not to mention the fact that the TSX has leapt 94% over the last 42 months,” it says. “Nonetheless, we expect this to be a normal pullback, and provide a chance for investors to reload for the next phase of the expansion.”