Active Minds – Treasury yields rise, but don’t worry about inflation
Active Minds – Treasury yields rise, but don’t worry about inflation
Ariel Bezalel looks at the bond market’s reaction to comments from some US Federal Reserve officials, and explains why he still isn’t worried about inflation. Meanwhile, Richard Watts asks what counts as a ‘value’ stock in early 2021, and Matthew Pigott welcomes a broader emerging market rally.
Treasury yields rise, but don’t worry about inflation
This year’s biggest event in the bond market has been a sharp move up in the US Treasury 10-year yields, which rose around 20 basis points and sit near 1.1% today, said Ariel Bezalel, Head of Strategy, Fixed Income. He sees this ‘mini taper tantrum’ as brought about by poor communication from some Federal Reserve (Fed) officials who discussed scenarios for tapering, or reducing bond purchasing, and even rate hikes.
This talk was later quashed by Fed Chairman Jerome Powell, and the move in Treasuries does not shake Ariel’s firm belief that rates will remain lower for longer, he said. With so much debt in the global economy – around $280 trillion and rising, and much of it unproductive – any jump in yields may well create volatility in risk assets and cause yields to fall back again. Ariel highlighted that there was a taste of that last week as stock markets and credit markets wobbled, and in his view we may not be far from the pinch point where higher yields start to hurt risk assets.
Credit spreads have had an amazing round trip post pandemic and are back to pre-pandemic tight levels, Ariel said. This reflects both the hunt for yield and the perceived central bank backstop (central banks do not want wider credit spreads). Ariel noted that inflation is being kept in check partly by weak wage growth. Labour does not have pricing power, and artificial intelligence, robotics and other technology make this a long-term trend, he said, adding that during the pandemic companies have worked out even more efficient ways to operate.
Ariel sees Chinese 10-year government bonds as very attractive with yields of 3.15% versus US Treasuries at 1.1%. China’s economy is growing strongly with no sign of inflation, while it has a contracting workforce, stagnant population growth and a credit bubble – similar to conditions in the developed world – which means that in Ariel’s view China is set to experience many of the macro-economic and demographic forces that have driven bond yields lower elsewhere in the developed world.
This talk was later quashed by Fed Chairman Jerome Powell, and the move in Treasuries does not shake Ariel’s firm belief that rates will remain lower for longer, he said. With so much debt in the global economy – around $280 trillion and rising, and much of it unproductive – any jump in yields may well create volatility in risk assets and cause yields to fall back again. Ariel highlighted that there was a taste of that last week as stock markets and credit markets wobbled, and in his view we may not be far from the pinch point where higher yields start to hurt risk assets.
Credit spreads have had an amazing round trip post pandemic and are back to pre-pandemic tight levels, Ariel said. This reflects both the hunt for yield and the perceived central bank backstop (central banks do not want wider credit spreads). Ariel noted that inflation is being kept in check partly by weak wage growth. Labour does not have pricing power, and artificial intelligence, robotics and other technology make this a long-term trend, he said, adding that during the pandemic companies have worked out even more efficient ways to operate.
Ariel sees Chinese 10-year government bonds as very attractive with yields of 3.15% versus US Treasuries at 1.1%. China’s economy is growing strongly with no sign of inflation, while it has a contracting workforce, stagnant population growth and a credit bubble – similar to conditions in the developed world – which means that in Ariel’s view China is set to experience many of the macro-economic and demographic forces that have driven bond yields lower elsewhere in the developed world.
Value’s rallying, but what is a ‘value’ stock right now?
A lot has happened in the last three months, since the US presidential election in early November and the announcements about vaccines, which spurred equity markets into a rally and a rotation to value, said Richard Watts, Head of Strategy, UK Small & Mid Cap. That trend has carried over into 2021, given further momentum by the Georgia Senate race that saw the Democrats achieve a clean sweep of Congress.
Richard highlighted that the outperformance of value over growth, and for small and mid caps over large caps, is especially pronounced in the US. The FAANGs have underperformed too, while the winners this year have been stocks that stand to benefit from fiscal stimulus. The same general picture is true in Europe, albeit to less extent, but in the UK it’s very different: large caps have outperformed, which is frustrating for a mid cap investor like Richard. He puts that disparity down to simply the kinds of exposure that the UK market has, with the large cap index much more weighted towards oil and banks compared to many other developed markets.
For Richard, the focus is on how 2021 will unfold; stock markets are looking through the grim headlines on high case numbers and deaths, to the vaccine rollouts and potential economic recovery to come later in the year. The second half of 2021 may see the strongest rate of global GDP growth for two or three decades, coming off last year’s low base. Regarding Brexit, Richard sees the Christmas Eve deal as being perfectly satisfactory, although the asset inflows into the UK market haven’t yet materialised, but that may change.
In general, he feels optimistic about the year ahead for the UK market, and for value, although one question on his mind at the moment is: what is a value stock right now? Richard and the team are looking at parts of the market that were ‘Covid losers’ last year, but some of them actually look rather expensive. So in seeking more value opportunities they are cognisant of the need to remain highly selective.
Richard highlighted that the outperformance of value over growth, and for small and mid caps over large caps, is especially pronounced in the US. The FAANGs have underperformed too, while the winners this year have been stocks that stand to benefit from fiscal stimulus. The same general picture is true in Europe, albeit to less extent, but in the UK it’s very different: large caps have outperformed, which is frustrating for a mid cap investor like Richard. He puts that disparity down to simply the kinds of exposure that the UK market has, with the large cap index much more weighted towards oil and banks compared to many other developed markets.
For Richard, the focus is on how 2021 will unfold; stock markets are looking through the grim headlines on high case numbers and deaths, to the vaccine rollouts and potential economic recovery to come later in the year. The second half of 2021 may see the strongest rate of global GDP growth for two or three decades, coming off last year’s low base. Regarding Brexit, Richard sees the Christmas Eve deal as being perfectly satisfactory, although the asset inflows into the UK market haven’t yet materialised, but that may change.
In general, he feels optimistic about the year ahead for the UK market, and for value, although one question on his mind at the moment is: what is a value stock right now? Richard and the team are looking at parts of the market that were ‘Covid losers’ last year, but some of them actually look rather expensive. So in seeking more value opportunities they are cognisant of the need to remain highly selective.
Welcoming a broader emerging market rally
Emerging markets (EM) have had a relatively strong start to the year, said Matthew Pigott, Assistant Fund Manager, Emerging Markets. For most of 2020, there was a lot of focus on the large North Asian markets – China, for example, has handled Covid-19 relatively well and has delivered strong market performance. But since the positive vaccine news in November, investors have started to look again at smaller EM markets.
This change to investor sentiment is something that Matthew and the team welcome – a greater focus on valuations, and more interest in smaller EM and even frontier markets, which have been out of favour for some time. A continued broadening of the EM rally from the perceived ‘safe haven’ markets that investors rushed to earlier in the pandemic is something to look forward to, said Matthew.
Mexico is one example where Matthew has started to see this change in sentiment. Mexico was not a popular place to be invested in for the majority of last year, along with most of Latin America – in periods of high stress, Latin America can often act as a ‘punching bag’ for EM investors, and Matthew said that was certainly the case in 2020. The Mexican peso depreciated around 30% in February-March, and the country handled the virus relatively poorly. Since November, however, Mexican equities have rallied strongly, though the market still isn’t back to pre-pandemic levels. Matthew and the team have had exposure there for some time, and they continue to identify several overlooked businesses that are still trading on extremely attractive valuations.
Elsewhere, Turkey is another country where Matthew and the team continue to find attractive investment opportunities. While it has been viewed as a ‘problem child’ of EM for the past few years, Matthew and the team have stuck with their investments there, primarily focusing on companies that are regional businesses, with significant non-lira revenues.
This change to investor sentiment is something that Matthew and the team welcome – a greater focus on valuations, and more interest in smaller EM and even frontier markets, which have been out of favour for some time. A continued broadening of the EM rally from the perceived ‘safe haven’ markets that investors rushed to earlier in the pandemic is something to look forward to, said Matthew.
Mexico is one example where Matthew has started to see this change in sentiment. Mexico was not a popular place to be invested in for the majority of last year, along with most of Latin America – in periods of high stress, Latin America can often act as a ‘punching bag’ for EM investors, and Matthew said that was certainly the case in 2020. The Mexican peso depreciated around 30% in February-March, and the country handled the virus relatively poorly. Since November, however, Mexican equities have rallied strongly, though the market still isn’t back to pre-pandemic levels. Matthew and the team have had exposure there for some time, and they continue to identify several overlooked businesses that are still trading on extremely attractive valuations.
Elsewhere, Turkey is another country where Matthew and the team continue to find attractive investment opportunities. While it has been viewed as a ‘problem child’ of EM for the past few years, Matthew and the team have stuck with their investments there, primarily focusing on companies that are regional businesses, with significant non-lira revenues.
Please note
Market and exchange rate movements can cause the value of an investment to fall as well as rise, and you may get back less than originally invested. The views expressed are those of the individuals mentioned at the time of writing, are not necessarily those of Jupiter as a whole, and may be subject to change. This is particularly true during periods of rapidly changing market circumstances.
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