Please see below for Brooks MacDonald’s latest weekly market commentary received by us late afternoon 01/03/2021:
In Summary:
- Yield rises remain the major driver of equity markets
- Johnson & Johnson’s single shot vaccine is approved in the US, adding to the breadth of vaccine supply
- Israel eases some restrictions as the UK is set to lay out its reopening plans
Yield rises remain the major driver of equity markets
Last week saw a large uptick in volatility as higher yields caused a sell-off in markets that focused on secular growth sectors such as technology. Meanwhile, previously unloved sectors such as banks performed strongly on the back of steepening yield curves and lower expected defaults in the future as the economy recovers.
Johnson & Johnson’s single shot vaccine is approved in the US, adding to the breadth of vaccine supply
The theme of the last few days has been a tightening of restrictions, rather than loosening, as several European countries needed to roll back liberties and Auckland, New Zealand entered a fresh lockdown. More positively, the Johnson & Johnson (J&J) vaccine has been approved in the US with the company saying they can ship 100 million doses in H1 2021. While the efficacy data was less compelling for the J&J vaccine, it is recommended as a single dose vaccine which makes the rollout of logistics simpler.
The change in yields has had an outsized impact on technology companies
The ‘price’ of a financial asset is the sum of its future cashflows adjusted for a discount rate. In practice this means the sum of a company’s future earnings which are adjusted for interest rates plus an extra company specific risk premium on top. Value companies tend to produce higher earnings now but less exciting earnings in the future. Growth companies, by contrast, produce little now but are expected to make outsized earnings in the future. Because the earnings in growth companies tend to be further away, the discount rate is more important. Due to the power of compounding, a small change in interest rates can significantly reduce the present value of future earnings 10 or 20 years away. This is exactly what happened last week when a pickup in interest rate expectations caused high growth companies to look less attractive. The moves were relatively small, with the US 10 year rising around 7bps to just over 1.4% but with valuations richer in the technology space, this was enough to catalyse a sell-off.
Of course, the question is whether central banks will let further yield rises happen. So far, the Federal Reserve have pushed back against expectations for sustained inflation but have broadly welcomed the pickup in yields, saying it is reflective of an improved economic backdrop. The next Federal Reserve (Fed) meeting is on 16-17 March, however this week we hear from a series of members including Fed Chair Jerome Powell. Should rapid rises in yields continue to be a theme, we expect the Federal Reserve to step in, at least verbally, to steady further rises. Yield rises can impact both financial stability and damage the economic recovery so central banks will be paying close attention.
Please continue to utilise these blogs and expert insights to keep your own holistic view of the market up to date.
Keep safe and well
Paul Green DipFA
01/03/2021