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