Government bond yields are rising, inflation concerns are building and global investors are partly rotating out of growth and into value.
Another year begins tumultuously, with government bond yields rising and global equity markets reacting in rollercoaster fashion. But right now, we see volatility as an opportunity – not a risk in the long term. Think back to March last year: stock-market pullbacks are an opportunity to add to positions in great companies at lower prices, or initiate new ones.
Stock market rotation within global sectors is also an opportunity for investors. And the disruptors operating within many of these sectors have created excellent opportunities in recent years, particularly over the past 12 months.
Many of these businesses have benefited from the pandemic, with accelerated growth and higher corporate profitability. And while some have been seen as expensive on the basis of certain valuation metrics (hence the recent rotation out of growth and into value), the likelihood is that this rotation will have made many of these companies’ share prices more attractive. Indeed, digital operators like Amazon, Alphabet and Facebook are now at valuations that are cheap – their lowest premiums to the overall market since their stock market listing.
While the rotational trade over the past six months has been value over growth, we believe that it makes more sense to have exposure to both quality growth and value. Owning quality growth stocks in businesses that offer a robust, competitive and disruptive edge, strong balance sheets and good management is sensible. And it’s also a good idea to own value – and be safe in the wisdom that the selective businesses you possess have good prospects.
It will rise in the short term, but central banks are unlikely to raise interest rates any time soon.
Now that the world is more certain of a strong global economic recovery, we should expect a new cycle of growth. This will create employment and lead to wage increases and inflation… and eventually higher interest rates. For that reason – as was the case in 2003 after the crisis triggered by 9/11, and then again in 2009 after the Global Financial Crisis – it is natural that there should be concern about high inflation and interest rates. Similarly, as the yield curve steepens and we enter the post-recession phase, there is a certain amount of trepidation associated with owning certain risk assets (such as equities).
The bond vigilantes have been beating their retreat drum, pushing the benchmark 10-year Treasury bond yield gains up by almost 60 basis points over the past couple of months. This has sparked fears of higher inflation, an asset reallocation to shorter-duration and cyclical assets, and a sell-off in technology stocks.
Again, this should be seen as a natural short-term phenomenon – a corrective phase on the path back to normality. Our focus, however, remains on the long term – what a post Covid-19 world will look like and what opportunities it will present for investors.
Inflationary pressures and interest rates.
In the meantime, the bond vigilantes and the US central bank are at opposite ends of the spectrum regarding their attitude to future inflationary pressures. Indeed, Fed Chair Jerome Powell and US Secretary of State Janet Yellen have recently indicated that they have no reason to believe that any pick-up in short-term inflation rates should warrant any increases in interest rates. So we are unlikely to see any rate hikes until 2023 at the earliest.
The bond vigilantes believe that the central bank is making a monetary error that it will eventually regret. Only time will tell who is right and who is wrong.
We do not expect further changes post-Covid-19 regarding our work patterns or our fondness for e-commerce. The development of robotics and automation, and the Green Revolution will all continue unabated. For more than a year now, people have been hunkering down and juggling work and leisure activities from the same Covid cave. But now, they are not quite sure if they actually want things to go back to the way they were.
For many, the pandemic has brought positive changes to their lives that they do not want to lose. But for others, the last 12 months have been fraught with fear, anxiety and depression.
What Covid-19 has done is make businesses and individuals give more thought to their working patterns and lifestyles. They have been more inclined to ditch their daily routines and strike a more meaningful balance between going to the office and working from home. And many find themselves valuing personal healthcare, financial security and quality time with their friends and families even more than they did before the pandemic.
Global pandemics may be rare, but the financial and human destruction that they leave in their wake are long-lasting. Fortunately, however, the remarkable technological progress made in recent years has drastically cut the time needed to develop a vaccine.
We amend our strategies accordingly
As many (but not all) global lockdowns lift and we move into spring, our investment focus is now firmly on a strong global economic recovery and the long-term opportunities that it might bring. We are therefore using this time to add to – and indeed tilt – our portfolio strategies, shifting the focus to recovery and factoring in the changing investment backdrop and the disruptive themes that are likely to reshape our world.
But the right portfolio will see you through
As vaccination programmes continue to temper the might of the pandemic, we need to consider another set of financial and economic challenges. Higher inflation and letting the economy run hot for a while will create further volatility in the financial markets. Bond yield will surge upwards, equity markets will be buffeted around by day-to-day events and geopolitical risks will remain.
Nevertheless, a thoughtful and considered approach should still result in respectable investment returns. Inflation does indeed lower the value of cash savings and fixed-income investments. But it is possible to offset inflation – by picking those assets that appreciate, are tangible or have rising dividends. Historically, global growth-orientated equities, index-linked bonds and tangibles (commodities, including gold) have been good assets to own during periods of higher inflation. That said, one is never entirely immune to the effects of inflation.
Finally, as the end of the tax year draws near, it is important to subscribe to your ISA or pension if you have not already done so.