The turbulence in markets persisted last week with the bond market selloff remaining in focus.
In the equity markets, the rise in bond yields has hurt high-multiple growth stocks most. Notably, a group of Chinese technology names has been hit by a confluence of headwinds alongside the negative impact of rising yields, which includes news that the US securities regulator has adopted measures that would delist Chinese companies from US exchanges if they do not comply with US auditing standards, and that a series of block sales hit the market on 26 March due to forced liquidation.
The technology sector is broadly the flag bearer of highly valued growth stocks and forms a major component of the equity market. In particular, in the US, FAANGM names alone (Facebook, Apple, Amazon, Netflix, Alphabet and Microsoft) form more than 20% of the S&P500’s market capitalization.
While the current environment characterized by 1)rising inflation expectations, 2) rising bond yields, 3) rising bond term premiums, and 4) rising real yields has been challenging for the technology sector valuations, we believe that the sector moves most closely with real yields.
Although we see some moderate upside for bond yields from here with our 12-month forecast for the US 10-year Treasury yield at 1.90%, our view for real yields is more tempered.
Given that real yields is nominal yields minus inflation, it follows that a move up in nominal yields driven by rising inflation expectations would be more subdued in real terms.
As for nominal yields, the bond market is already reflecting fairly aggressive expectations for Fed normalization and the move up is likely self-limiting should bond yields continue to rise further.
To illustrate, Eurodollar futures now are reflecting a likely liftoff by Dec 2022, which is significantly more aggressive than the Fed’s and our base case.
While it is indeed true that the normalization of Fed policy has historically been strongly associated with market drawdowns, barring far worse inflation than anticipated ahead any further shift in bond market expectations over the near term to a 1H2022 liftoff seems unsustainable.
Over the next 6-12 months, we believe that cyclical stocks will have more room to perform as the real economy continues to gradually re-open.
Cyclical sectors, including energy, commodities, industrials and banks, have historically performed well during regimes of rising bond yields.
Mobility trends, such as TSA checkpoint travel numbers and OpenTable restaurant reservations are still not at pre-pandemic levels but are gradually recovering with the vaccine rollout underway.
Ultimately, in evaluating the current market turbulence, the overarching question is: does the rise in bond yields primarily reflect an ongoing economic recovery or does it threaten it? The answer is the former, in our view.
Finally, abundant liquidity factors and ultra-supportive monetary policy continue to buttress the post-pandemic bull market. Less than half of the cumulative increase in US money market fund holdings due to the Covid-19 crisis has been reversed to date, which points to more dry powder for the market.
More liquidity support is expected to come in the form of the recently passed USD1.9 trillion US pandemic aid package as it is disbursed. In addition, as highlighted in our previous paper, the White House is anticipated to subsequently focus on an infrastructure bill to rebuild the United States’ aging fixed assets.
Tentatively touted at a very broad range of USD2-4 trillion, this is significant given that the current value of government infrastructure in the US is about USD6 trillion.
