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19 February 2021, 3 mins.
In 2018, Jonas Blue released a song titled Rise in which he sings “We’re gonna ri-ri-ri-ri-rise ’til we fall.” Over the past few weeks, bond markets have been singing along with Jonas, and bond yields have moved higher. Since the start of the year, US 10-year bond yields have risen from 0.9% to 1.3%, and UK 10-year bond yields have risk from 0.2% to 0.6%.
In their 2021 outlook pieces, market commentators warned that one of the big risks facing markets over the next 12 months would be bond yields rising too quickly. Why? Well, equities look expensive by most valuation metrics, except those which compare equities to yields.
With bond yields rising this much, one would think equities would be down for the year. This has not been the case. In sterling terms, global equities are up 4% this year, whilst ‘value’ stocks are up 9%.
How should one make sense of this? Well, the rise in bond yields has been accompanied by upgrades in earnings forecasts and GDP projections. Last week, after the 4Q 2020 earnings season, Goldman Sachs increased its 2021 S&P 500 earnings per share (EPS) target from $178 to $181. This number was $170 as recently as November 2020.
Earnings per share is not the only number Goldman Sachs is upgrading. On Wednesday 17th February, the bank upgraded its 2021 US real GDP forecast to 7.0%. This is the fourth revision since the turn of the year, when the number was 5.3%.
With these higher growth forecasts, the debate has turned to “will there or won’t there be sustained inflation?” Unfortunately, delving into that conversation takes longer than this short note but it is top of mind for investors. The debate between Larry Summers and Paul Krugman is a good starting point for those interested by this subject.
For now, it looks like bond markets think that inflation will rise, which is why yields are doing the same. For equity markets, the risk of inflation is outweighed by the fruits of higher economic growth. If this trend were to continue, investors may wish to hold an underweight allocation to bonds.
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