Higher growth -> higher inflation expectations -> higher bond yields
One often-discussed reason for market uncertainty is that long-term government bond yields have climbed due to increased inflation expectations, in turn based on expectations of better economic growth (in itself a favourable trend, of course).
Ten-year US Treasury yields climbed above 1.3% last week. On the one hand, this means that Treasury bonds may actually be an alternative to equities as a source of returns. On the other hand, Treasury yields are also used for calculating the present value of future stock market returns. The higher the yield in the denominator, the lower the present value of future dividends and valuations.
Government bond yields are now also climbing outside the US. They are starting at low levels, and we believe this trend reflects positive risk appetite in a logical way. According to last week's Bank of America fund manager survey, institutional investors are optimistic about growth and expect rising yields and inflation. They also believe that share valuations are high but are not in a general bubble.
Stimulus from both governments and central banks
The USD 1.9 trillion "American Rescue Plan" – a new stimulus bill that is one of the main causes of current inflation worries − was approved by the Budget Committee on February 22 and will be up for a vote by the House of Representatives later this week.
In light of rising long-term bond yields, markets have also focused on the actions of central banks. After a speech this week by Christine Lagarde, President of the European Central Bank (ECB), euro zone yields subsided again. On February 23 and 24 (today), US Federal Reserve Chairman Jerome Powell is testifying before Senate and House committees after delivering the Fed's semi-annual Monetary Policy Report to Congress.
Addressing the Senate Banking Committee, Powell repeated the Fed's earlier message that the US recovery following the COVID-19 pandemic will continue to require support from both fiscal (i.e. budgetary and stimulus package) and monetary (no key interest rate hikes and continued bond purchases by the Fed) policy makers. "The economic recovery remains uneven and far from complete, and the path ahead is highly uncertain," he said.
Rising oil prices for longer dated contracts
Brent crude oil prices climbed above USD 66/barrel earlier this week, partly due to unusually cold winter weather in Texas – home of a large proportion of US oil refineries, which had to shut down for several days. The OPEC+ countries will hold a meeting on March 4 and are expected to update their (limited) oil production quotas. SEB's current forecast is rising oil prices for longer dated contracts. Read more here.
Our market view
Recovery will support stock markets
Negative news about the spread of COVID-19 and rising long-term US Treasury yields are creating stock market turmoil, which led to downturns on most major exchanges last week. In itself this is not surprising, since last year's sharp stock market recovery is reason for caution.
Our main scenario is unchanged, however. We anticipate a clear economic recovery starting this spring or summer, with solid growth at least well into 2022. Due to a combination of continued large stimulus measures and an accelerating economy, inflation risks are emerging on the agenda and thus also worries about a continued climb in government bond yields, especially in the US. We expect only limited upturns in yields, but if they turn out to be faster and larger than this, they are likely to have a negative impact on the stock market mood.
In an economic recovery, cyclical value companies should be able to regain lost ground, but looking further ahead the digitisation trend will continue to benefit growth companies. Sizeable worldwide investments in sustainability suggest that last year's strong performance for companies with this type of strategy may continue.
Share valuations today are undoubtedly high from a historical perspective but can be justified by lower interest rates and bond yields as well as a strong earnings outlook. These high valuations limit upside potential in the long term, but they are rarely a good signal to sell in a short-term per¬spective.
Continued potential, though a lot has been priced in
Given today's low interest rates and yields, it is hard to find good alternatives to stock market returns. Meanwhile, central banks and governments have established a floor by promising continued stimulus.
This suggests that the growth picture will have to become much worse, and/or yields will have to climb much more than expected, for major stock market downturns to materialise. However, profit-taking − with downturns of 10 or perhaps 15 per cent − will still be a natural element of this picture. We nonetheless expect positive, single-digit stock market gains this year.