Monthly macro update: March 2021
Snapshot of views
Bond yields rose throughout February, but do higher yields pose a threat to equities? We don’t think so, for now, as yields are rising for the ‘right’ reasons (as explained below). The economic environment is still positive for equities, and we continue to believe any inflationary pressure that comes from re-opening economies will be short-lived given still high unemployment and structural deflationary forces, such as an aging population. Our preference for sectors and companies tied to the economic cycle, as opposed to tech/growth names remains.
Are rising bond yields a threat to equities?
Low bond yields have been supportive of our positive view on equities as cheap borrowing supports corporate investment. So, does the increase in bond yields so far in 2021 pose a threat? We think they do not, as the change in yields is primarily the result of improving growth expectations and investor preference for risk assets (i.e. the ‘right’ reasons). If yields were moving higher due to fears of significantly higher inflation, which would likely be countered by central banks raising interest rates, then we would be more cautious.
While inflation expectations have risen in the past few months as confidence in the path of recovery has increased, they are moving from a bit below long term targets (so 2% in the US) to a bit above, which we think is consistent with confidence in a post-Covid economic recovery. We believe that long-term inflation expectations are unlikely to rise significantly quickly given unemployment, particularly in the US, remains well above pre-Covid levels and it will take time for this to correct. Additional fiscal support, including $1.9 trillion in the US, is not in itself a reason for inflation and yields to rise. The yields on corporate bonds have risen less than Treasuries as credit spreads have continued to tighten as investors believe that corporate defaults are less likely.
High Yield credit spreads have proved resilient despite the rise in Government Bond yields, Bloomberg, March 2, 2021
Does volatility suggest investor apprehension?
We previously cautioned the Covid-19 recovery would be turbulent and result in market volatility, and in that respect, markets have behaved exactly as expected. Bouts of volatility have materialized multiple times in 2021 leading to temporary market corrections, but it is important to note that equity market volatility is the norm, not the exception. Since 1960, the average yearly S&P 500 high-to-low decline has been approximately 14%, yet over 75% of those years have resulted in positive equity returns. But with increasing talk of assets being overvalued, are we at risk of bigger and sharper declines? Last month’s Macro Update discussed how equities would benefit from earnings growth, and we are already seeing evidence of this. Earnings growth has outpaced P/E growth year to date (the ratio of company’s price to company’s earnings), a reversal of 2020. We expect this trend to continue as economies re-open, providing equity markets with a stronger footing. Earnings growth will likely support those companies that suffered the most in 2020 and benefit cyclical sectors (those sectors more exposed to the economic cycle). While our underlying thesis that cyclical companies will outperform still holds, we may increase allocations to defensive companies and, when prudent, reduce equity exposure.
Source: Bloomberg, March 2, 2021
Are record equity inflows a cause for concern?
A record $58bn flowed into equity funds in the second week of February 2021 as vaccine rollouts and further stimulus improved investor sentiment. Technology focused funds were the primary beneficiaries, with the US the most favored region. While this reflects the consensus view that equities will be the core drivers of returns this year, we should be wary of overexuberance. This is exactly why we believe asset allocation within equities is crucial. We will continue to be tactical around the equity allocation to access regions, sectors and styles that provide the best risk and reward tradeoffs, for example, our current preference for non-US equities which have more cyclical sector exposure as shown in the asset class views below.
Source: Bloomberg, March 2, 2021
Investment advisory services are provided by River and Mercantile LLC, an investment advisor registered with the US Securities and Exchange Commission. It is a subsidiary of River and Mercantile Group PLC, a U.K. corporation.
The information and opinions contained in this document do not constitute investment advice and is provided for background purposes only. References to specific securities are provided solely as illustrative examples of the River and Mercantile LLC analytical methods, and are not a recommendation to buy or sell such securities. This information is subject to updating and verification. Portions of this presentation are based on data provided by third parties whom River and Mercantile LLC deems to be reliable; however, River and Mercantile LLC cannot guarantee the accuracy and completeness of the information.
PAST PERFORMANCE IS NOT AN INDICATION OF FUTURE RESULTS.
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