Rising Bond Yields, Equities and 'Bubble Trouble'
Posted 09 February 21
Interview with ausbiz, 8 February 2020
During this interview, Paul Ashworth our Chief Investment Officer, outlined his thoughts on bond yields, equities and 'Bubble Trouble'.
Cameron Harrison does not see rising bond yields as a critical concern for equity markets through 2021. The reasons for some upward movement in bond yields, largely through economic growth pickup are positive for earnings as is some modest increased inflation. That said, for every action there is a reaction. A return to greater equity market volatility and performance based on individual company merits should be expected (and largely welcomed). As for ‘Bubble Trouble’, we are concerned for some sector valuations, but in the absence of high leverage and given a now broader economic base for earnings growth, we think a potential price adjustment can be confined to technology and the specific growth sector participants, rather than the broader market.
Here are the key summary points from the interview:
- Rising bond yields with no increase in real yields, have since the early 2000’s been correlated with positive outcomes for equity markets (Figure 1 below), this is relevant for where we are and where we are going over 2021
- A strong fiscal response should not automatically be translated to significant increased inflationary expectations, escaping bond rates or ‘bubbles’. Japan for 20 years is ample illustration that low rates with low inflation doesn’t automatically create a bubble. ‘Bubble Trouble’ tends to come from over leverage which is not present at this stage (but a material risk).
- Earnings growth stimulated by fiscal policy and supportive monetary policy is a positive (as is some wages growth) and should be supportive of earnings stability and a lower equity risk premium.
- The key adverse risks are either mitigated or low at this point in time, namely:
• Hawkish Central Banks raising rates – central banks are largely coordinated in their rate setting and market support activities at least through to 2024, and
• Significant inflation expectations are not currently present
- We would caution however that tantrums, corrections and equity volatility should be expected. We are moving past the linear line of recovery where all ills and hopes have been equally and positively assessed. Markets now move to analysing and assessing the form of the next economic cycle and individual enterprise merits. Earnings growth is potentially more widely dispersed across the sectors of the economy and equity capital potentially has more options to invest in rather than just growth and technology - we advocate ‘smart industrials’ which are strategically well managed for the modern business cycle, 'plugged' into a broader industrial economic uplift and trade on a reasonable 18x cyclically adjusted PE for the S&P 500.
- Finally, as for ‘Bubble Trouble’, Cameron Harrison does see big valuation problems for certain sectors such as technology, but taking our earlier comments, economic growth reflation allows equity capital to find new, broader based investment sectors – ‘Bubble Trouble’ is really the combination of valuations which are untethered to any reasonable medium term fundamentals and high leverage. At this stage, we do have untethered valuations, but leverage is not so high as to be alarming (at this stage).
Peace of Mind Investing
Cameron Harrison have been advising business owners and their families on asset allocation and intergenerational wealth management for over 50 years. We have demonstrated over a long period our ability to manage investments through both the good times and bad by keeping the client at the centre of our business.
For more information on our approach to investment strategy or any other inquiries, please contact us on +613 9655 5000.
Photo by Ricardo Gomez Angel