Investment Letter MARCH/APRIL/21

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by Vincent WEGHSTEEN
March 16th, 2021  –   4 min read

Impact of rising government bond yields

on your investments in bonds

Higher bond yields have arrived. The 10-year Treasury yield topped 1,50% last week (+0.52% last summer), its highest level in more than a year. The 10-year German Bund topped -0.205% last week, coming from -0.65% in November and the 10-year Belgian Bond topped +0.13% last week, coming from -0.43% end of November 2020.

The expectation remains for yields to keep climbing over coming weeks and months. Since Pfizer/Biontech announced in November that they had a vaccine, the yield curve accelerated its climbing.

The market does expect that with people being vaccinated and the further stimulus aid the pace of global economic reopening will accelerate. A potential spike in inflation could also be around the corner.


Should we fear higher yields?

Most market strategists say investors should expect a challenging yield environment this year as the Federal Reserve and the ECB are expected to keep rates at historically low levels.

As society moves to a post-pandemic world, the outlook for bonds will evolve, with hopes that economies will improve as vaccines are distributed. An improving economy could lift bond yields, but it may also spur inflation, something investors should watch.

Short term interest rates (less than 3 years) are highly correlated and sensitive to Fed and ECB actions. We don’t expect a whole lot of movement in that part of the yield curve.

The longer-term rates (above 5 year) will likely be influenced by growth and inflation expectations. As 2021 moves into the second half of the year, those longer-dated rates may rise as vaccine distribution improves, allowing the economy to reopen and gross domestic product growth accelerate.
Combined with monetary and fiscal stimulus, inflation expectations may increase, causing the yield curve to slope up as rates for longer-dated maturities rise.


Profit taking in longer-dated rates?

We do think it would be advisable to take partial profits on long bond positions as we had nearly 40 years of falling interest rates. Remember the nearly 16% on the 10-year Treasury at the end of 1981. Or the 11.50% on the 10-year German Bund also at the end of 1981.

The question is, where do we invest the cash if we want to stay out of more risky assets? Without any doubt, cash is one possibility for the coming months. Another possibility is to consider investing in investment-grade corporate bonds and emerging markets government bonds.

During 2020, investment-grade corporations issued a record amount of debt as they sought to raise cash during the pandemic, and now these companies have “a war chest liquidity”. Sectors to follow are energy and leisure, both massacred in 2020.

Emerging-market, US dollar-denominated sovereign bonds, which have yields of 4.7% and some Asian high-yield bonds with 7% yield are to be considered too.

But don’t forget: high quality bonds should make up the bulk of any bond portfolio!

Vincent Weghsteen
Analyst Nucleus Group

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Investment Letter MARCH/21

Business photo created by @drobotdean – www.freepik.com

by Vincent WEGHSTEEN
March 4th, 2021  –   4 min read

Rising government bond yields:

Is inflation coming back and will it hurt the stock market?

In our Global Market review 2021, we pointed to some downside risks for investors in 2021, nil climbing interest rates!
The message we receive from the bond market is the come back of inflation. The rising yield curve since a few weeks spell trouble for stocks.

The rising yield curve came with the announcement of Pfizer/Biotech in November that they had a Covid-19 vaccine. There is an expectation in the market that with people being vaccinated, the pace of global economic reopening will accelerate.

Two key economic releases last week fuelled enthusiasm about the economic recovery.  Case in point were the industrial production and retail sales releases.

The industrial production continues to improve for the fourth month in a row, but the year-over-rear change is not back in positive territory yet.

Retail sales was even more of a stand-out-significantly besting even the most optimistic of economists’ estimates.  Retail sales hit a new record high in January, of course helped by the latest round of USD 600 fiscal relief.  The recent strength is probably a preview of what’s to come after the passage of the “American Rescue Plan” currently being negotiated in Congress.

Existing home sales have clearly staged a V-shaped recovery.  The lack of supply continues to push prices higher, with an increase of 14,1% year-over-year of an existing home sold in January.
But consumer confidence shows no recovery.  Consumers’ assessment of current business and labour market conditions fell in January although expectations about the future outlook improved.  In contrast to consumers’ more dour near-term view, the CEO confidence has improved to a near-record high- and significantly higher than at any point during the 2009-2020 economic expansion.

So, is inflation next?
The PPI, producer price index, surged a record 1,13% in January, well above expectations.  Fiscal relief has boosted demand to a degree that has overwhelmed supply, which continues to be hampered by pandemic related supply chain problems and delivery bottlenecks.

On the contrary, Consumer Prices remain subdued.  Gasoline price increases drove headline CPI up in January, however, inflation more broadly, remains subdued.

What about the stock market?
The expectation remains for yields to keep climbing over coming weeks and months.  And a key question is how high yields need to be to dent stock-market returns.

Almost 70% of S&P500 companies pay a higher yield than the 10-year note.  That proportion will fall to 40% if companies keep their pay-outs at current levels and the Treasury yield rises to 1,75% by the end of this year (currently 1,46%).

That could start undermining the attractiveness of stocks as an income play.  Today the overall dividend yield on the S&P500 is 1,50% higher than the 10-year Treasury pay-out.  The implied long-term return of the S&P500 is around 3%.  Most strategists don’t expect the 10-year note to be able to challenge that return soon.

Goldman Sachs strategists wrote that a quick jump in Treasury yields would be dangerous for the stock market.  Real damage would require yields to rise 36 basis points in the span of a month. This looks unlikely.

So, bonds will likely become marginally more attractive in coming months, but it is not clear that such a shift will be enough to undermine stocks, especially as long-term bond returns are most at risk from rising yields. So, while Treasuries could provide a better alternative to stocks someday, that process could take longer than investors might think.

Stay tuned,

Vincent Weghsteen
Analyst Nucleus Group

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