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Higher bond rates, slower economy

30 Sep 2021 20 day(s) ago

In the end, when interest rates are near zero, they can only go in one direction. Some analysts are expecting bond yields to rise and negatively affect the share market.

For the big investors, who shift the market, the relationship between bonds (fixed interest) and shares continues to be important. When the yields (interest rate) on bonds rise, that usually means that share prices get weaker as the money flows towards the bonds. Of course, in reality the markets are far more complex than that, but strategists usually start at that point.

Macquarie is arguing that bond yields are likely to rise, and that this has impliciations for shares, especially as the economy is slowing.

“Rising (bond) yields are not a 2020 redo, as we are in a slowdown (not an expansion). In late 2020, we were at the start of a new Expansion, where growth was accelerating with the support of re-opening, policy stimulus, rising commodity prices and a weaker USD. All this favoured the outperformance of cyclicals, value, resources and bond yield beneficiaries.

“But the market context today is different, with more cross currents. The US cycle has been slowing since April and this tends to favour the outperformance of defensives. Secondly, we see downside risk for commodities due to: i) slowing China growth, ii) a shift in spending from goods to services; and iii) a stronger US dollar as the Fed tapers.”

Macquarie is advising reducing exposure to Mining but kept an exposure to Energy which was more negatively impacted by the pandemic. “Bond yields would typically be falling in response to slowing momentum in the US and China’s cycle. Yet, we still expect bond yields to rise in the near term as markets front run tapering by the Fed, or driven by market expectations of policy changes not the economic cycle. ?

“In other words, the expected rise in bond yields is counter-cyclical. This matters because a rise in bond in a slowdown creates a cross-current in stock (shares) selection.”

Macquarie says rising bond yields increase the earnings from interest bearing assets (e.g. for insurers, banks or CPU) nut are negative for companies with high debt. They say all else being equal, rising bond yields are a headwind for valuations; it is a negative for share prices. Of course, in such complex markets, all else is rarely equal.

Macquarie suggests exposure to General Insurers, such as IAG, Suncorp and QBE, and the Banks, especially ANZ and Westpac.

“In terms of indirect earnings impacts, Energy stocks are well positioned given oil demand was negatively impacted by COVID and should be supported by re-opening. The Energy sector also has a low valuation on cyclically low earnings. The contrast here is Mining where some stocks also have low valuations, but this is capitalising a period of above average earnings.”

The ‘pandemic’ is also a factor in picking stocks, according to Macquarie. “We continue to favour re-opening plays given the rising vaccination rate. This is a key positive difference to late 2020 when effective vaccines were first announced. But we think performance can be more stable given a vaccinated population is less likely to get locked down again. ?

“We still think defensive positions are warranted given the slowdown, prefer Staples (Coles, Endeavour Group, Woolworths) and Health.”

 

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