Even though the underlying force behind bond market moves is an improving economic outlook, higher rates are raising fears that the equity rally could fizzle. The recent volatility has been concentrated in growth/technology stocks that are seen as vulnerable to higher discount rates. In fact, the beta of the Nasdaq 100 to treasuries has neared record levels. (Chart 1)
So, is good economic news bad news for risk assets? No, we believe good news really is good news.
In our view, the surge in bond yields is reflective, not constraining. In other words, the level of yields remains accommodative considering the economic environment. Historically, rising yields have only hurt stocks in response to hawkish central bank rhetoric. This is clearly not the case today. Chair Powell via the Fed’s new framework has downplayed inflation risks, stressing that the US economy is “a long way” from their goals.
And inflationary hopes have so often disappointed because of secular deflationary trends that are not done playing out. After an initial surge of leisure and services spending, we think consumption reverts to trend as structural forces reassert themselves. Therefore, there will be a short-term pickup in inflation because of base effects from 2020, but we believe these risks are already priced into markets. (Chart 2)
Given a broad economic rebound and well-contained inflation, we continue to overweight equity exspoure and remain convicted in our positions. The bond selloff is exhausted (for now), but when rates do move higher again, we expect the unusual correlation to growth stocks to subside.
With this month moves, we sold our short-term bond position to put capital to work in emerging market equities and initiated a tactical position in long duration bonds to take advantage of the outsized move in yields.
Finally, know that all our Strategies will adapt to fundamental or rules-based, not emotional influences. We seek opportunities for solid risk adjusted returns and to preserve capital in asset market downturns.
1 Information as of 03/02/2021. Individual account allocations may differ slightly from model allocations.
Recent Portfolio Changes
We exited our cash equivalent position in favor of Emerging Market Equities and a small Long-Term U.S. Treasuries position. Tactical moves to add risk in a position at a more attractive reentry point. The Treasury add is a mean reversion play on a very sharp increase in long-dated yields that we feel may have been overdone or “too much too soon.”
We initiated a position in U.S. Infrastructure Development. We believe this space will benefit from a potential increase in infrastructure activity in the United States, a main priority of the Biden Administration.
We initiated a position in Minimum Volatility Emerging Market Equities. To maintain cyclical exposure in our barbell approach, while mitigating downside risk due to potential extended conditions. We believe that international stocks should benefit from improving global growth and a weak USD environment as the year progresses.
1 Information as of 03/02/2021. Individual account allocations may differ slightly from model allocations
John A. Forlines III
Chief Investment Officer
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