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Bond yields catching up with equity optimism

Source: Refinitiv, 31.3.21, total returns in USD

(as at 31 Mar)
2016-2017 2017-2018 2018-2019 2019-2020 2020-2021
S&P 500 17.2 14.0 9.5 -7.0 56.4

Past performance is not a reliable indicator of future returns. When investing in overseas markets, changes in currency exchange rates may affect the value of your investment. 

Perhaps unsurprisingly, stock markets have lost some momentum in the past three months. They are higher than they started the year but the remarkable recovery that began last March has started to run out of steam. As the old saying goes, it can be better to travel than to arrive.

To understand why investors have become more nervous you need to look not at the stock market but at bonds. While shares were edging towards new highs in the first quarter, it was the 10-year Treasury yield that was capturing the headlines. Bull markets climb a wall of worry and the focus of those concerns today is the risk that maybe we can have too much of a good thing. Stimulus is good but too much stimulus risks re-igniting inflation.

The challenge for investors is deciding what’s underlying any return of inflation. If it is a reflection of the re-opening of the economy, the success of the vaccination programme, people getting back to work and travelling again, then that’s good news. If it is a reflection of reckless money-printing, a populist desire to maintain people’s income whatever the cost, well maybe it’s not so helpful.

Unfortunately, we won’t know the answers to those questions until it is too late. Managing an economy is an art not a science. It’s an ongoing experiment. What we do know is that the stakes are very high. The sums involved are gargantuan.

My gut feeling is that shares will continue to scale the wall of worry this year. Governments are committed to providing the support their economies need. And they have enlisted the support of their central banks. No-one should stand in the way of this determination - and so far it does not look as if they are. Flows into global equity funds in the first quarter stood at record levels.

In a broadly optimistic environment, riskier assets like shares are the place to be and, within the stock market, more cyclical areas should continue to outperform. The rotation from growth to value looks likely to continue but any sign that bond yields are no longer moving higher may re-ignite interest in last year’s winners.

We are clearly moving beyond the Hope phase of the market in which returns are driven by higher valuation multiples and into the Growth phase where rising earnings pick up the baton. The bad news is that price gains in the Growth phase are lower than in Hope. The good news is that this phase of the cycle is usually the longest. A period of lower but more sustainable gains beckons.

This analysis chimes with the assumption that we are part way through an extended post-financial crisis bull market. I suspect that in years to come we will look back on the pandemic as a short and unpleasant shock, which investors ultimately took in their stride.

Select 50 fund picks: As the analysis of fund picks on previous pages shows, some of the best funds on the Select 50 are to be found in the global category. Investing in this way has the added benefit of being simple, handing the responsibility for geographic allocation to an investment expert. The funds we particularly like are Rathbone Global Opportunities and Fidelity Global Special Situations. Before you invest in a fund, please ensure you have read Doing Business with Fidelity and the Key Information Document (KID) relevant to your chosen fund.


Bonds: little compensation for corporate risk

Source: Refinitiv, 31.3.21

Past performance is not a reliable indicator of future returns. When investing in overseas markets, changes in currency exchange rates may affect the value of your investment. 

Bonds are supposed to be boring. Today they are not. Most investors tend to focus their attention on stock markets, but the headlines are currently all about bond yields. The echoes of the 2013 Taper Tantrum (and earlier disorderly periods in the markets such as in 1994) are loud and clear.

What everyone is focused on is the rise in government bond yields shown clearly in the chart in the Shares section above. The rise in yields is the consequence of a fall in bond prices (they move in opposite directions) and bonds have experienced one of their worst quarters in decades.

Bond investors are worried about inflation. They rightly see it as the enemy of fixed income returns. Anyone familiar with the long-term performance of bonds will know that inflation is a killer. And the reason they are worried about inflation? Well you don’t have to look further than the US government. Spending $8.5trn on defeating the coronavirus may be the right thing to do but it comes with significant risks.

The past 40 years or so have lulled bond investors into a false sense of security. A generation and more of falling interest rates has provided a tailwind for bonds. With yields close to zero, that bull market has nowhere to go. The only question is whether interest rates and bond yields are anchored at today’s low levels or start to rise significantly from here. 

So, the risk of holding government bonds is higher than we have believed in recent decades. And the return for taking it is paltry. The good news is that after the recent rise, a bond yield can once again fall back to zero, providing a capital gain. In a low interest rate world that might provide some support.

When it comes to corporate bonds, the outlook is not much brighter. As the chart opposite  shows, the expectation of an economic bounce back from the pandemic has reduced to historically low levels the gap between safe government bond yields and those on less safe corporate bonds. Investors are now accepting almost no compensation for the greater risks they are taking by lending to companies rather than governments.

It is true that less secure companies (the issuers of so-called high yield bonds) do offer something of a premium. But even here, as the red line on the chart shows, the income is not that much higher when you factor in the greater chance that a company will default.

The area of the bond market that looks most interesting is in emerging markets where both government bonds and corporates offer more yield than in the developed world and arguably not that much greater risk. It’s thin pickings though. Bonds offer investors a degree of diversification, but you are paying a high price and taking a big risk for a small benefit.

Important information: 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.


Unlike shares, commodities really do reflect what is going on in the world as we speak. Shares look to the future, but commodities are real assets and their price reflects demand in the here and now. This partly explains why metals and oil have slightly run out of steam in the past quarter. China looks less interested in stimulus than the West and fears of new infection waves have temporarily put the brakes on re-opening in some places.

But the case for a new structural bull market in commodities remains strong once we get over this short-term hump. There are three main drivers. The first is vaccines which will provide a major boost to demand for commodities as people start to travel and consume again.

The second driver is also about demand but this time a more permanent shift. It’s to do first with governments’ approach to the Covid shock, a new focus on income redistribution towards lower income groups who are more likely to consume than save. It’s also about solving the climate crisis. Ultimately this will demand huge spending on commodity-intensive infrastructure. Goldman Sachs analysts think that might add up to $16trn over a decade.

The third driver is supply. After years of excess investment and oversupply, the problem now is a lack of spending thanks both to Covid disruption and a desire to invest less and return cash to shareholders. Shortages are already showing up.

Commodities are a great diversifier in a portfolio. During the crash in 2000, commodity markets rallied strongly even as shares lost half their value. They also perform well in an inflationary environment.


The real estate market continues to be driven by the ‘gravity of yield’. With an acceptable income hard to find in the bond market, the return on prime property assets of 3-4%, often with long, secure income streams, continues to be compelling. Obviously, property yields need to be higher to reflect illiquidity and depreciation but, even so, the sector is still relatively attractive to income seekers.

The UK is likely to be a beneficiary of this wall of money thanks to the higher yields available here, even after Brexit. The completion of a free trade deal with the EU, albeit with some teething problems, has taken away some of the perceived risks of investing in the UK and an extra 1% of income will at the margin tempt back some capital from the more in-favour European markets.

There are risks in the sector. First and foremost, the changing nature of the post-Covid economy means money is pouring into hot areas like online logistics. Expectations of rental growth may be disappointed, and price rises in the sector have been rapid. Another risk is that investors compromise on quality as they chase yield. In a new working world in which offices are competing with desks at home, only the best environments will attract tenants. A third risk is the danger of extrapolating from the experience of the past year into the future. Some things have changed for good; in other ways the new world may look surprisingly like the old one.

Important information: Funds in the property sector invest in property and land. These can be difficult to sell so you may not be able to sell/cash in this investment when you want to. There may be a delay in acting on your instructions to sell your investment. The value of property is generally a matter of a valuer's opinion rather than fact.

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