Declining global bond yields and flattening yield curves remain the most important development in financial markets during the past week. The US 10-year yield hit a five-month low last week while German yields fell by 10bps. Equity relative outperformance during the past five weeks has shifted back to the tech megacaps. Even Stay-At-Home stocks are starting to outperform after peaking many months ago (chart below). These changes in momentum have been closely correlated with the recent surge in global cases of corona. Is the corona pandemic coming back to top the list of investor concerns?
Source: Strategas Research Partners
The global vaccine rollout is much more advanced compared to previous surges in cases. The graphs below highlighting the UK situation are not dissimilar to those of other developed countries. While there has been a surge in cases, there has certainly been a delay in this translating to severe pressure on hospital resources and ultimately rising deaths. There is a legitimate concern that the pace of the economic reopening will be slowed but other indicators which we monitor currently show no expectations that this will have a meaningful impact on economic growth.
Source: Strategas Research Partners
The first chart below monitors the credit spread between investment grade and sub-investment grade debt. In times of rising economic stress this spread should widen. In contrast, this spread has been remarkably stable at historical very low levels by historical standards.
Bron: Bloomberg Finance
In addition, corporate earnings estimates for this year and into 2022 remain strong. The first chart below highlights analysts’ expectations for +64% earnings growth for the Q2 reports about to get underway – the strongest growth since 2009. The second chart shows that estimates for 2022 continue to climb which would be inconsistent with rising expectations of slower economic growth in that year.
Source: Strategas Research Partners
Source: Strategas Research Partners
Our base case remains that we have yet to see the highs in yields or earnings and that the market recovery will continue to be led by the traditional value sectors. We currently view the pull-back in global yields and short-term outperformance of megacap Tech as more a healthy mean reverting occurrence rather than signaling some longer-term change in trend. These mean reverting moves are not uncommon. Looking back over the past 20 years, there have been two occasions where bond yields made meaningful upward moves. In both cases there were sizeable pullbacks along the way which did nothing to harm the upward trend (charts below).
Source: Bloomberg Finance
Source: Bloomberg Finance
Based on the weight of current evidence we view the current market rotation as a normalization of extreme investor positioning and rising optimism (both charts below). Flows into the more economically sensitive sectors has turned negative and are approaching levels that would signal that the short-term selling should subside. In contrast, inflows into bonds have risen significantly and should shortly reach a level consistent with an overbought condition. Deteriorating market breadth and elevated investor optimism do suggest that short-term positioning should not be overly aggressive. The summer months should present better opportunities to deploy our current cash position.
Source: Strategas Research Partners
Source: Bloomberg Finance
