NEWS Rare to see periods of rising bond yields and falling equity prices 40
Equities Up, Yields Down 34% of the time
Equities Up, Yields Up 34% of the time
Equities Down, Yields Down 19% of the time
Equities Down, Yields Up 13% of the time
3m % Change in MSCI World
30 20 10 0 -10 -20 -30 -40
-4
-3
-2
-1
0 1 3m % Change in US 10Y
2
3
Source: Morgan Stanley
John Paulsen, chief strategist at research house Leuthold agrees, and points out that since 1900 whenever rising bond yields stayed below 3%, stocks have thrived. Government bond yields in the US and UK are certainly nowhere near the 3% level at present. IS THE MARKET TOO RELAXED ABOUT INFLATION? The reflation narrative and assumption that central banks will keep a lid on interest rates for longer, regardless of higher inflation, has arguably become the consensus view and priced into markets. For example, the latest Bank of America fund manager survey showed cash levels had been whittled down to eight-year lows while allocations to commodities were at their highest since 2011. In other words, investors have already gone ‘all-in’, spurred on by accommodative central bank policies. Investment bank ING’s comments on inflation illustrate the consensus view very well. It says: ‘We are all aware the run rate of monthly inflation
numbers has picked up a bit, no one really expects inflation to push up and stay at levels that will require central bank tightening anytime soon, especially not the Fed (US Federal Reserve) or the ECB (European Central Bank)’. But with the US $1.9 trillion fiscal stimulus likely to be voted through in March and a strong rebound in economic activity already baked in, some observers see the prospect of pent-up consumer spending as potentially worrisome for markets. One such observer is Chetan Ahya, chief economist at Morgan Stanley, who believes that US policy makers have been very generous supporting households and businesses. SPENDING SPREE AHEAD? In aggregate, US households will have around $2 trillion of excess savings assuming the latest package is passed and Ahya argues that consumers are only holding onto savings because their spending options have been limited. Pent-up demand could lead to a splurge in spending once economies fully open, paving the way for a ‘regime shift’ towards higher inflation. The risk of higher inflation is heightened by the huge national debts that have been built up to deal with the economic damage inflicted by the pandemic. This may crimp central banks’ policy response should inflation overshoot, allowing inflationary pressure to get out of control. It’s noteworthy that more institutional investors have added inflation protection strategies to their armoury including the controversial gold alternative, bitcoin. UK fund manager Ruffer is backing cryptocurrency bitcoin, believing it is only in the early stages of being adopted as a mainstream asset. The firm has since seen a return on investment of up to £693 million after the currency surged to record highs above $50,000. ANOTHER ISSUE TO CONSIDER Finally, there is some debate about the common wisdom that higher inflation is good for equities and bad for bonds. Companies need to replace assets over time and if inflation drives prices of plant and machinery higher, then historical profits and returns on capital are overstated, leading to theoretically lower valuations for shares. [MG] 25 February 2021 | SHARES |
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