By Hussein Sayed, Chief Market Strategist at FXTM
Inflation threats and rising bond yields have been the dominant market topics over the past several weeks. Many investors fear the latest selloff in bonds and rise in long term interest rates will put an end to the fastest and strongest bull market in history.
Significantly, it is not only the US which is seeing bond yields rise. Long term yields in Germany, Japan, China and many other major markets are all fast approaching pre-pandemic levels. While this may indicate that inflation is returning, it also suggests investors are gaining confidence in the economic recovery and corporate earnings growth.
Corporate earnings are expected to recover at a much faster pace than previous crises, thanks to the trillions of dollars being pumped into the global economy and several investment banks have started revising their earnings forecasts higher for 2021. That could offset the negative aspects of rising long-term interest rates.
Federal Reserve Chairman Jerome Powell assured the markets over two days of testimony to Congress that an interest rates increase is nowhere near. He continues to see price pressures as muted and says the economy is a long way from the Fed’s employment goals. Hence, easy monetary policy will continue beyond this year, even if some inflation metrics surprise to the upside over the coming months.
Given those factors, I assume the bull run is likely to continue for Q1 and Q2, but not necessarily in a straight line. Despite the assurances from Chair Powell, equity investors will need to keep a close eye on long-term yields. The energy, industrial, material and financial sectors are the ones to benefit most from the reflationary environment and may be positively correlated to the rise in bond yields. But the technology sector that currently makes up 38% of the S&P 500 market cap is at risk if yields move much higher.
The rising interest rate environment makes it less appealing for investors to increase their proportion of growth stocks in their portfolios. They are already expensive compared to historic metrics and many stocks within the sector are trading at extremely high multiples. It’s now time to become more selective and focus on quality companies with reasonable price tags within the Tech industry.
The choppy movement in Tech stocks over two days last week has been a kind of warning signal. Investors highly exposed to this growth sector may need to build some downside protection.
