Bassanese Bites: Good news is bad news – March 01 2021

Global markets

The ‘bloodbath’ in global bond markets continued last week, with U.S. 10-year bond yields ending the week up another 7bps to 1.41%. A poorly supported U.S. 7-year Treasury bond auction appeared to be the catalyst for last week’s further yield gain, with assurances from Fed chair Powell (not even thinking about ending QE anytime soon!) only stemming the sell-off for a couple of days. U.S. 10-year yields in fact had a closing high of 1.52% on Thursday. The speed of the move suggests a technical/stop loss clean-out of many investors who had been picking up yield at the long-run of the curve – on the expectations that the long-rate would remain contained. They did get pennies for a while, but the steamroller finally arrived.

As would be expected, equities buckled further under the yield onslaught, especially growth sectors such as technology and consumer discretionary (CD). Helped by higher oil prices, the global energy sector managed a 2% gain, while financials (whose profit margins benefit from a steeper yield curve) only dropped 0.6%. Technology and CD dropped 4.7% and 5.6% respectively, making last week a decisive win for value stocks over growth.

Economic news, meanwhile, remained very encouraging (which also contributed to bond nervousness) with strong gains in U.S. durable goods orders, a sharp drop in weekly jobless claims, U.S. regulatory clearance of a new one-dose vaccine, and passage through the U.S. House of Reps of Biden’s totally unnecessary massive new stimulus bill. As I’ve said, the U.S. economy appears to be on a tear – strong growth in the economy and corporate earnings is very likely this year, though whether it will deliver the sustained lift in inflation that bond investors are worried about is much less clear.

Where to now? As it stands, long bond yields now appear reasonable near-term value on the basis of sustained sub-2% inflation and and no signals of Fed tightening for at least a year. That said, as explained in last week’s Bites, the big near-term risk at least is a short-run spike in inflation which could lead to a further capitulation among bond investors and pullback in equity markets (where 20+ PE valuations have been predicated by low sustained bond yields).   A move in U.S. 10-year bond yields to 2% seems entirely possible on a few high U.S. inflation readings in coming months, which could easily create conditions for a decent 10% correction in equity markets.

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