Weekly Market Update: Investors dilemma: Cheaper bonds or returning dividends?
Mon 08 Mar 2021
Markets returned to positive territory this week, supported in part by progress on the Biden stimulus bill. However, chair of the Federal Reserve Jerome Powell’s speech, with a lack of updates to current policy, disappointed investors leading to a sell-off on Thursday afternoon. US equities rose +1.7% in Sterling terms. UK equities rose +2.5%, with UK equity markets benefiting from rising oil prices. Emerging Markets grew +0.9% in Sterling terms, although this was a more moderate +0.1% in local currency terms. Globally the best performing sector was Energy, whilst IT was the worst performing, as the rising yield environment impacted valuations. Japanese equities rose +1.0%. The US 10Y yield continued its rise, up 16.1 bps to 1.6%, while the UK 10Y fell 6.4bps to 0.8%. Gold fell -1.1% on the week. Oil rose sharply, up +8.4% on the week to $66.5 following the OPEC meeting where it was decided to hold production at current levels, when a rise in production had been anticipated.
Between a very generous post-Brexit and Pandemic budget, the approval of $1.9tn worth of stimulus in the US and a continuously steepening yield curve, last week offered a lot of news. However, in terms of long-term investing, none was as important as Jerome Powell’s laconic “patient” response to rising fears of inflation. True to their Pavlovian reflexes, traders were hoping that the recent bout of volatility could mean extra monetary accommodation and were disappointed when the Fed stayed put. Subsequent price action was negative.
While it is true that cost pressures over the past few months have begun to spill over to consumers, and could well be exacerbated by rising oil prices, it is apparent that the Fed is keeping its eye on the ball, which is long rather than short term inflation. Post-stimulus unemployment and growth concerns, vaccine nationalism and the rising possibility of vaccine-resistant Covid-19 strings and belief that supply chains will adjust quickly are on the Fed’s side of the fence. Current data and market pressures are on the other.
Where investors couldn’t find income, now they are faced with a dilemma. If one stands with central banks – historically there has been little other choice for long term portfolio managers -and believes that this “inflation scare” will go away soon, then one can view the bond market as increasingly providing investors with entry points. However, fixed income is still expensive relative to equities and the risk/reward profile at an index level is still not hugely attractive, especially at the lower end of the credit spectrum. Investors might just yet prefer equity income as companies scramble to return to a regime of good dividend payments and buybacks.
There is still some way to go before asset allocation committees can be overweight bonds again. And when they do, they should be wary of the impact of rising rates to corporations, or indeed countries, with over-burdened balance sheets that need to refinance debt. The business world and nations have used debt to weather the pandemic and every day that goes by brings the inevitable debtor-creditor showdown a tiny step closer. And this, for us, is the heart of the matter. If our analysis suggested that yield curve steepening was reflecting credit fears, we would have said that it is premature, but nevertheless a valid concern. As long as people are speaking only of inflation, then we feel more comfortable staying on the central bank’s “patient” side of the fence.
David Baker, CIO