The rise in U.S. Treasury yields has caused fluctuations in global stock markets recently. We argue that stock investors need not be too worried over higher bond yields. Sector allocation may play a key role here: prefer cyclicals over growth.
- Higher bond yield reflects better economic growth. Treasury yields usually move in tandem with U.S. GDP growth rate and manufacturing PMI. The rise in bond yields in recent months is a result of vaccination-driven economic recovery and higher inflation expectations due to strong commodity prices.
- Bonds yields are still quite low and real yields negative. After the recent rebound, Treasury yields are still at the trough over the past decade. More importantly, real yields (inflation-adjusted) are still negative in major developed countries, which means businesses and consumers should not be discouraged from borrowing by positive real yield. Negative real yield is also a supportive factor for equities, as U.S. equities usually did well as long as real yield on 2-year Treasury stayed negative.
- Fed’s “average inflation targeting” means no rate hike for years. Inflations will possibly rise further in the months ahead, but since the Fed has now adopted an inflation target of “averaging 2% over time”, and Fed Chair expects the increase in inflation should be short-lived and reiterates to keep monetary policy highly accommodative, we believe a repeat of "taper tantrum" is unlikely.
- Stock prices tend to rise along with bond yields. Empirical evidence shows that stock prices have been positively correlated with bond yields. There could be some divergence over short periods, but over the medium term (3-6 months), they were positively correlated for most of the time.
- Expect cyclicals to extent outperformance. Cyclicals started to outperform growth stocks since Sep-Nov 2020, and we believe they will continue to outperform in coming weeks due to: 1) Vaccinations improve outlook of global economy and thereby earnings of cyclicals; 2) Higher bond yields and expected inflations are more favourable to cyclicals; 3) Cyclicals are still extremely cheap compared to growth stocks; 4) Southbound net buying of HK stocks have sharply decreased, putting downward pressure on growth stocks which were favoured by Mainland investors.
- HSI may remain volatile but range-bound. As we expect cyclicals to outperform while growth sector be under pressure, they may somewhat offset each other in their contribution to indexes’ performance. Expect the HSI to be range-bound in 28,000-31,000 in coming weeks. Volatility of benchmark indexes will probably remain high, as FY20 and 1Q21 results could bring extra fluctuations.
