Important information: The value of investments and the income from them, can go down as well as up, so you may get back less than you invest.
If you’re anything like me, you’ve probably grown quite used to your own company this past year. I’ve usually considered myself a fairly sociable guy, but now the prospect of meeting up with friends and going out is back on the table, I’m suddenly met with a strange apprehension.
Markets are suffering from something similar.
Investors have had nearly 12 months now to get used to ultra-low interest rates and depressed economies. In that environment, they fled to the comfort of defensive, growth-heavy tech stocks at the expense of just about everything else.
All that changed on November 9, when Pfizer first announced its vaccine. An effective vaccine proposes to turn the (shudder) “new normal” investors had gotten used to on its head. It offers hope that the virus can be contained and that economies will recover. It also implies an eventual end to the massive stimulus packages that have buoyed valuations since their April nadirs.
Consequently, the four months since have served up evidence of a gradual rotation away from the big pandemic winners (think Amazon and Apple in the US, Ocado over here) and towards the cyclical losers, whose prospects are more closely tied to the overall health of the economy.
That’s been demonstrated in the relative outperformance of so-called “value” stocks (typically comprising the pandemic losers) over “growth” since November. Another marker has been steadily rising bond yields.
What happened on Thursday was the most dramatic sign yet that markets aren’t quite prepared for normal. Most of all, they’re scared of being reacquainted with an old friend, inflation.
Inflation fears are always first seen in the bond market. That’s because it’s the asset class with most to lose. Inflation erodes the value of the fixed interest you earn on a bond as well as the capital you receive when it matures.
That concern led many investors to sell off their bonds. Due to the inverse relationship between bond prices and yields, falling prices result in rising yields.
The 10-year US Treasury yield rose over 1.6% last night, its highest level since March.
Movements in the US Treasury yield are felt far and wide. All bonds are priced by comparison, meaning that government and corporate bonds across the globe will sing from a similar hymn sheet.
But its impact isn’t limited to bonds. Most startling about yesterday’s selloffs were their ricochets across global stock markets. The S&P 500 index of the US’ largest companies fell 2.5% yesterday. This morning, Japan’s Nikkei fell 4%, Hong Kong’s Hang Seng was down around 3.4%, and China’s CSI 2.4%.
Why did bond selloffs roll over into equity markets? There are a few reasons. At the simplest level, the bond selloff freaked investors into jumping ship on shares too.
But there are more technical reasons too. The first is one of relative appeal. The mantra of 2020 was that shares looked cheap compared to bonds. A fall in bond prices diminishes one of the major pulling powers for shares over 2020.
That’s also affecting the relative appeal of equity yields. With bonds yielding next to nothing since Covid struck, many investors took a step higher on the risk ladder and looked to equities as a source of income. If the gap between the two narrows, then shares become that little bit less attractive to investors.
Our old friend inflation has a part to play here too. Inflation threatens to erode the value of future earnings for those companies which are expected to deliver rising earnings long into the future (i.e. most of the “growth” companies that did best last year), in much the same way that inflation is bad for the fixed interest you earn on a bond.
Inflation expectations may also lead to higher interest rates, and these too affect shares. Growth companies benefit from a low rate environment where the opportunity cost of waiting for their future value to emerge is lower. As such, rising rates pose a risk to such companies.
That’s why some markets have been hit harder than others. The tech-heavy Nasdaq fell 3.5% yesterday, 1% further than the more tech-agnostic S&P 500. Shares in the biggest US tech companies, such as Facebook and Amazon, have all fallen in recent days. Scottish Mortgage, the Baillie Gifford investment trust with large holdings in Tesla and other tech giants, has been today’s biggest faller on the FTSE 100.
The FTSE 100 itself has remained relatively robust. In part that’s due to a falling pound (confusingly, when the pound falls the FTSE 100 tends to rise because of its international focus) but it’s also shielded by its relative lack of exposure to those sort of tech giants. What hurt our market last year could well be a saving grace this year.
What happens next? It’s too soon to call. Yields could continue to rise - bond selling tends to beget more bond selling. There are fears that if rises don’t abate soon, we could see a repeat of the 2013 ‘Taper Tantrum’, when the US Federal Reserve’s decision to reduce its Treasury bond purchasing panicked investors and pushed yields higher. But the Fed has made clear its intention to control yields this time. It may choose to gobble up more and more Treasury bonds to flatten the yield.
In the meantime, investors may stay wary of riskier assets and look instead to safe havens. The enthusiasm for Emerging Markets with which the year began is already cooling off. A strengthening dollar will also hurt these markets.
Whether this is a full-scale rout remains to be seen. What is clear is that this is another jitter in the long and “unprecedented” road back to normal, and the ensuing shift from high-flying growth stocks to out-of-favour value.
It’s also an opportunity to take a step back and consider how well diversified you are to cover all eventualities. If you ploughed all your money into last year’s winners, you’ll be feeling the pain today. If you spread your holdings across geographies, asset classes and styles, you gave yourself the best chance to come out unscathed.
The Fidelity Select 50 Balanced Fund is a multi-asset fund which offers investors a one-stop shop to a diversified portfolio of holdings. A defensive fund like this should cope well with bouts of volatility such as that we’ve seen today.
Important information: Investors should note that the views expressed may no longer be current and may have already been acted upon. Reference to specific securities should not be construed as a recommendation to buy or sell these securities and is included for the purposes of illustration only. Overseas investments will be affected by movements in currency exchange rates. There is a risk that the issuers of bonds may not be able to repay the money they have borrowed or make interest payments. When interest rates rise, bonds may fall in value. Rising interest rates may cause the value of your investment to fall. Due to the greater possibility of default an investment in a corporate bond is generally less secure than an investment in government bonds. Select 50 is not a personal recommendation to buy or sell a fund. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to an authorised financial adviser.