The rapid rise in yields has spooked equity markets, with the 10-year US Treasury briefly touching 1.6% on Thursday, having been beneath 1% at the start of the year. Highly rated technology companies have suffered steep falls, whilst companies whose earnings should disproportionately improve in an economic recovery, have proven to be relatively defensive over the week.
As of 12pm on Friday, London time, US equities have fallen 2% over the week, whilst US technology companies sold off by 5.4%. European equities, less exposed to technology, whilst having greater exposure to economically sensitive companies, fell 1.8%, with UK stocks having lost 0.8%. The UK stock market is even more economically exposed, whilst the UK is further ahead than most in the vaccine rollout providing confidence of a more imminent economic recovery. UK mid cap stocks, which are typically more exposed to the domestic economy, have risen by 0.8% over the week. Japanese equities fell 3.3% and Australian stocks were down 1.8%. Emerging markets lost 3.2%, with Chinese stocks falling 5.1%, as investors have become concerned that policy makers will start to withdraw monetary and fiscal support given the Chinese economy has recovered so strongly from the impact of COVID-19.
In contrast to technology stocks, global energy stocks rose over 6%, metals and mining increased by 2.8%, as did global banks, whilst global airline stocks rallied by over 9% over the week.
As of Friday, US 10-year Treasuries have settled back down to a yield of 1.47%, whilst German bund yields have risen to -0.25% and UK gilts 0.82%, with the latter returning to levels last seen pre the COVID-19 pandemic.
Along with investors expectations of accelerating economic growth, crude oil continued its ascent, with Brent crude almost hitting $68 a barrel intra week, before settling down at $65.9 a barrel. Meanwhile, gold fell by 1% over the week, now trading at $1,759 an ounce.
Issues under discussion
Markets’ attention has increasingly focused on concerns over rising inflation, and therefore rising interest rates, despite assurances from the chair of the US Federal Reserve, Jay Powell, that monetary policy will remain accommodative. It is the speed of the backup in yields that has concerned investors, rather than the overall move, with expectations that such a level in Treasury yields would probably have been reached by mid-year, rather than the end of February. However, when looking at longer periods of history, yields remain at extremely low levels which are unlikely to be a headwind for an economic recovery.
We think the rise in yields should be viewed as a return to levels seen prior to the pandemic, which in the case of the US, could see 10-year yields rise further still, to around 2%. However, for any equity priced at a very high valuation, whose earnings would benefit comparatively little from an economic recovery, this will undoubtedly lead to a fall in value. A number of technology companies would fall into this category, by no means all, but in the short term the stock market does not differentiate.
It should also be recognised that rising yields, if not kept in check, would at some point become a headwind for all assets, but we think the risks of this are low and the moves so far should be viewed through the lens of an economic recovery which is positive for equity markets, even if it creates short term volatility.