What does the 100-year Austrian bond tell us about other asset classes?

There has been lively debate (see here and here) around Austria’s 100-year government bond and the fact that investors who bought the bond at issuance have lost more than two-thirds of their capital value to date. Coupon income does little to change that conclusion. Much of the discussion has focused on more technical aspects such as convexity, or on whether it was rational to buy extremely long-duration bonds when yields were at record lows.

While these are interesting questions, we believe the episode is at least as informative when viewed through a broader asset allocation lens. In particular, it raises an important question: if long-duration bonds performed so poorly as interest rates rose, why did other long-duration assets — notably equities — perform much better?

Since 2021, global interest rates have risen by roughly 300–500 basis points. Given our estimated equity durations of around 21 years for the EuroStoxx 50 and 26 years for the S&P 500, a purely rate-driven framework would imply a large negative return for equities. Yet the realised outcome was very different. European equities have returned more than 75 percent since mid-2020, when the Austrian bond maturing in 2120 was issued — nowhere near the losses implied by the move in rates. While equities declined in 2022, even there the magnitude of the decline was smaller than implied by the move in rates – indicating that other factors were at play.

To understand this apparent disconnect, we decompose equity returns into three components: changes in expected dividend growth, changes in nominal interest rates, and changes in risk premiums. Within this framework, there are two potential explanations.

The first is that there was a large, coincident increase in expected dividend growth across horizons. Empirically, this did not occur, as shown in the chart below. Dividend growth expectations have moved only marginally, not nearly enough to offset the mechanical impact of higher discount rates.

The second, and more plausible explanation, is that the increase in risk-free rates was largely offset by a compression in the equity risk premium. In effect, discount rates for equities remained broadly stable, even as nominal yields rose sharply.

This pattern — a relatively stable cost of capital for equities rather than a stable equity risk premium — is not unique to the most recent tightening cycle. It appears to be a structural feature of equity markets. For example, declining interest rates following the Global Financial Crisis were accompanied by increasing equity risk premiums. More often than not, risk premiums have offset movements in rates, partially insulating equity valuations from large swings in interest rates.

This helps explain why linking asset prices to macroeconomic developments is often difficult in practice. Many investors expected tight monetary policy in the post-Covid period to trigger a major equity sell-off, but the realised outcome was far more nuanced. Equities performed well during a period of aggressive rate hikes precisely because risk premiums compressed as rates rose, more than compensating for the negative impact from higher discount rates.

The consequence is that long-horizon expected returns on equities are now low by historical standards and unusually close to expected returns on government bonds of equivalent duration. In relative terms, equities are far more expensive than they were when yields were near zero.

The period of exceptionally low bond yields in 2021 created a favourable valuation environment for equities relative to government bonds. Four years on, valuations point to the mirror image of that environment. These are not tactical signals, but multi-year considerations with horizons of 3–5 years. It is precisely this dynamic — gradual shifts in key return drivers — that makes strategic asset allocation both interesting and economically meaningful.

The broader lesson is the importance of decomposing asset returns into macro drivers. This is central not only to estimating expecting returns but also to assessing the riskiness of asset classes, either through scenarios or simulations.

A natural next question is why the cost of capital for equities remains so stable across cycles. There are emerging theories and a growing body of empirical evidence addressing this issue — but more on that next time.