At 2.5% for the MSCI AC World index, the rise in global equities in March was close to February’s 2.2%. It wasn’t all smooth running, though, as the advance of equities was challenged by a rise in US bond yields on the back of a favourable economic outlook that also prompted inflation fears.
More virulent variants of coronavirus have given rise to a third wave in Europe where rising infections and delays in vaccination campaigns have forced many governments to step up containment measures such as curfews and lockdowns, even at a risk to the reopening of their economies.
Factors that could have destabilised markets, such as geopolitical tensions and the Suez Canal container ship blockade, had only temporary effects. This implies that investor nervousness over the rise in bond yields is, perhaps, also somewhat overegged and could be shrugged off equally.
Major central banks commented on the higher yields, sometimes encountering scepticism, but on the whole it is clear sharp rises in long-term yields will not be tolerated and that the time for policy normalisation is still far off.
Global demand appears to be improving, as shown by the sharp rise in global trade and the strength of Chinese economic indicators as well as many business surveys. The OECD welcomed the prospect of increased fiscal support for the US economy and raised its growth forecasts for 2021 significantly from 4.2% in December to 5.6%. It highlighted a ‘considerable improvement’ in recent months.
It is striking that both the upside and downside risks the OECD pointed out relate to the vaccination drive. By contrast, the possibility of economic overheating and accelerating inflation have dominated bond markets in recent weeks.
The 10-year T-note yield (1.40% at the end of February) ended March at 1.74% for a rise of 34bp in one month and 83bp since the beginning of the year. During the month, it repeatedly surged to above 1.75% to levels that had not been seen since January 2020. These gains reflected the improving growth outlook for the US economy. This is basically how the US Federal Reserve has been viewing the higher yields.
There is some bond investor concern over the size of the US budget deficit as Congress approved the latest support plan, for a massive USD 1.9 trillion, and President Joe Biden presented the next package – a more than USD 2 trillion infrastructure investment plan.
Finally, inflation expectations and questions over the US Fed’s stance have been an important factor behind US Treasury performance. At the latest monetary policy meeting, chair Jerome Powell’s dovish comments seemed, at first, to convince investors, but the 10-year T-note yield later rose again.
Market-based inflation expectations have risen further: 5-year inflation breakevens ended the month at 2.60% and 5-year inflation expectations in 5-years (5Y5Y inflation swaps) rose to above 2.40%. The outlook for stronger economic growth led to a steepening of the yield curve, with the spread of 10-year yields over 2-year yields reaching 158bp at the end of March, marking the highest since July 2015.
The rise of US long-term bond yields explains the underperformance of emerging equities (-1.7% for the MSCI Emerging index in dollars), accentuated by the appreciation of the US dollar.
It also led to a significant outperformance of the value style over growth stocks. The S&P Value index rose by 6.0%, while the tech-heavy NASDAQ was almost unchanged at +0.4%. The S&P 500 set another record.
In the eurozone, equities rose by 7.8% despite the worsening pandemic situation as economic indicators generally confirmed the upbeat outlook. The purchasing manager index (PMI) rose to 52.5 – an eight-month high. This reflected the healthy state of the manufacturing sector, particularly in Germany and France.
April’s PMIs might look less rosy given the more stringent lockdowns curfews, but thereafter the prospect of a return to a form of normalcy should bolster confidence, particularly on the services side.
Although the human toll of the COVID-19 pandemic has worsened further, 2021 can still be seen as the year of the cyclical recovery thanks to the progress on vaccinations. GDP growth forecasts have been revised up, especially for the US, given the highly proactive fiscal policy there. There are hopes for additional fiscal efforts in the eurozone as it deals with a third wave of the epidemic.
In this buoyant environment, one could worry about a surge in inflation. Indeed, over the next few months, an acceleration might be seen. However, it would be due to transitory factors.
The medium-term scenario is favourable for risk assets as accommodative monetary policies and fiscal measures will support the recovery. Against this backdrop, we continue to view equity sell-offs as buying opportunities and we could further increase our exposure to commodities.
The recent movements on long-term bond yields call for a flexible asset allocation, not only between asset classes, but also within the fixed-income bucket where the search for yield means one needs to look at all market segments (emerging debt, inflation-linked bonds) and consider yield curve strategies.
Any views expressed here are those of the author as of the date of publication, are based on available information, and are subject to change without notice. Individual portfolio management teams may hold different views and may take different investment decisions for different clients. The views expressed in this podcast do not in any way constitute investment advice.
The value of investments and the income they generate may go down as well as up and it is possible that investors will not recover their initial outlay. Past performance is no guarantee for future returns.
Investing in emerging markets, or specialised or restricted sectors is likely to be subject to a higher-than-average volatility due to a high degree of concentration, greater uncertainty because less information is available, there is less liquidity or due to greater sensitivity to changes in market conditions (social, political and economic conditions).
Some emerging markets offer less security than the majority of international developed markets. For this reason, services for portfolio transactions, liquidation and conservation on behalf of funds invested in emerging markets may carry greater risk.