Investment strategy

Yield turbulence unlikely to derail equity bull

01 March 2021 • 3 mins read

As the vaccine rollout continues, major economies are slated to attain herd immunity over the next 12-24 months; our forecast is that US GDP growth would improve sharply from -3.5% in 2020 to 6.0% in 2021 whereas world GDP growth would rise from -3.4% to 5.9%.

A boost in the demand-side of the economy is anticipated to set off reflationary pressures, particularly due to supply chain weakness and lean inventories in the direct aftermath of the pandemic. As a result, higher inflation expectations are driving a steepening of the yield curve, and this is a largely healthy phenomenon that should not surprise investors in the initial recovery phase after a recession.

A disruptive move in Treasury yields, however, tends to cause turbulence in equity markets, especially for the valuations of high growth names that are more sensitive to interest rates as their future earnings are discounted at higher rates into present value.

While a further sharp increase in yields could portend more volatility in equities ahead, we do not expect this upswing in yields to derail the longterm post-pandemic bull market. To put things in perspective, real yields remain very low and the US 10-year real yield will likely stay in negative territory in 2021.

While we expect nominal 10-year US Treasury yields to gradually move closer to 2% over the next 12 months, the recent upswing has already been fairly sharp and if yields continue to move up rapidly from here, then a dovish shift in tone from the Fed seems likely ahead, which could take the form of explicitly ruling out any tapering of QE until 2022.

First, the rates market now reflects expectations of a first Fed rate hike in 2023 and four hikes by the end of 2024 – which seems aggressive given that the US will likely need to see full employment in the labor market before inflation levels can rise above 2% for a sustained period, potentially a year, before a first hike is justified.

Second, while higher yields driven by reflation is a healthy phenomenon at this stage of the cycle, a move that is overdone may not be consistent with the Fed’s plan in terms of progress towards full employment and inflation. Clearly, higher yields will also have an offsetting effect on the momentum of the property market recovery and also risk an overly disruptive correction in equity markets and sentiment.

We have previously discussed how this part of the business cycle where inflation is low and rising is beneficial for cyclical/value sectors, and have in our asset allocation strategy overweight positions in the energy, financials, industrials, materials and real estate sectors .

These sectors have outperformed the broad market since early February as inflation expectations and Treasury yields began moving upward sharply.

We do expect major technology stocks, such as FANG (Facebook, Amazon, Netflix and Google parent Alphabet), to underperform value/cyclical sectors over the next 6 to 12 months and have been advocating some moderate rebalancing from technology into value/cyclicals but we see this more as a tactical rather than strategic move.

We see the earnings potential of high growth sectors, such as technology, being the greater factor that would drive long term appreciation.

In particular, it will be important for investors to seek diversified exposure to structural growth themes such as e-commerce, rise of the cloud, AI, 5G, renewable energy, health tech, electric vehicles, smart cities and green infrastructure. The key question for many investors is what to do with their holdings in the technology sector.

Important information
This product may only be offered: (i) in Hong Kong, to qualified Private Banking Customers and Professional Investors (as defined under the Securities and Futures Ordinance); and (ii) in Singapore, to Accredited Investors (as defined under the Securities and Futures Act) and (iii) in the Dubai International Financial Center to Professional Clients (as defined under the Dubai Financial Services Authority rules) only. No other person should act on the contents of this document.This product may involve derivatives. Do NOT invest in it unless you fully understand and are willing to assume the risks associated with it. If you have any doubt, you should seek independent professional financial, tax and/or legal advice as you deem necessary.

Please carefully read and make sure that you understand all Risk Disclosures, Selling Restrictions, and Disclaimers. This document must be read together with the relevant Prospectus & Offering Documents &/or Key Fact Statement.

Disclaimer
This document is prepared by Bank of Singapore Limited (Co Reg. No.: 197700866R) (the “Bank”), is for information purposes only, and is not, by itself, intended for anyone other than the recipient. It may contain information proprietary to the Bank which may not be reproduced or redistributed in whole or in part without the Bank’s prior consent. It is not an offer or a solicitation to deal in any of the investment products referred to herein or to enter into any legal relations, nor an advice or by itself a recommendation with respect to such investment products. It does not have regard to the specific investment objectives, investment experience, financial situation and the particular needs of any recipient or customer. Customers should exercise caution in relation to any potential investment. Customers should independently evaluate each investment product and consider the suitability of such investment product, taking into account customer’s own specific investment objectives, investment experience, financial situation and/or particular needs. Customers will need to decide on their own as to whether or not the contents of this document are suitable for them. If a customer is in doubt about the contents of this document and/or the suitability of any investment products mentioned in this document for the customer, the customer should obtain independent financial, legal and/or tax advice from its professional advisers as necessary, before proceeding to make any investments.

The Bank, its Affiliates and their respective employees are not in the business of providing, and do not provide, tax, accounting or legal advice to any clients. The material contained herein is prepared for informational purposes and is not intended or written to be used, and cannot be used or relied upon for tax, accounting or legal advice. Any such client is responsible for consulting his/her own independent advisor as to the tax, accounting and legal consequences associated with his/her investments/transactions based on the client’s particular circumstances.

This document and other related documents have not been reviewed by, registered or lodged as a prospectus, information memorandum or profile statement with the Monetary Authority of Singapore nor any regulator in Hong Kong or elsewhere.

This document may not be published, circulated, reproduced or distributed in whole or in part to any other person without the Bank’s prior written consent. This document is not intended for distribution to, publication or use by any person in any jurisdiction outside Singapore, Hong Kong, or such other jurisdiction as the Bank may determine in its absolute discretion, where such distribution, publication or use would be contrary to applicable law or would subject the Bank and its related corporations, connected persons, associated persons and/or affiliates (collectively, “Affiliates”) to any registration, licensing or other requirements within such jurisdiction.

Author:
Eli Lee
Head of Investment Strategy
Was this page useful?