LONDON: Many of JPMorgan Chase & Co.’s clients are worried that the rise in bond yields threatens the stock market rally. For the broker and a number of major fund managers it’s actually a blessing.
This month’s retreat in fixed income has fueled concerns about the possible risk to the equity bull run. Yet, so far, the stock market has defied the doomsayers, and the reason behind the jump in yields -- improved economic optimism -- has reassured the likes of Eaton Vance Management and Fidelity International that the rally can continue.
The flight from havens and crowded bond proxies has triggered a switch into equity sectors that are more sensitive to the economy. The broadening of the gains to include value and cyclical stocks will support the rally, said JPMorgan in a note to clients. In the past decade equities rose every time bond yields spiked by at least 50 basis points, climbing by 6% on average, it said.
The cause for the shift in sentiment is key to understanding the equity market’s nonchalant attitude toward the bond market sell-off. The rise in yields happened amid optimism that the U.S.-China trade talks will continue, which is a positive signal for economic growth and as a consequence, for stocks.
"Government bond yields offer less of a signal for equity investors than they have in the past, ” said Eddie Perkin, chief equity investment officer at Eaton Vance Management. "If bond yields are rising due to optimism about the economy, that should be good for equities, especially since a lot of recession fears had recently been priced into the equity market." If the yields continue to climb rapidly or the economic picture becomes overly rosy, fueling speculation about a halt to central bank rate cuts, things could "get scary” for stocks, according to Legal & General’s John Roe. But this appears unlikely, he said.
Modest investor positioning in stocks also supports the bulls. Despite the MSCI World Index posting a 17% return in 2019, investors have pulled $198 billion from global stocks, while $342 billion surged into bonds as traders sought havens amid trade-war-related concerns.
"Bond yields have moved too far year-to-date as we are not expecting a recession, ” said Nick Peters, a multi-asset portfolio manager at Fidelity International, which oversees about $413 billion and favors equities. "As a result, we could see a sell-off in bonds without equities being impacted in the short term.”
Stocks are traditionally sensitive to sharp moves in debt, with the latest example occurring last month, when the inversion of the yield curve fueled a retreat from riskier assets. But the correlation between bonds and equities remains "resolutely” negative and higher yields shouldn’t pose a problem to stocks, according to JPMorgan.
"Higher yields usually go hand in hand with improving inflation and growth outlook, ” said JPMorgan strategists led by Mislav Matejka. "This is usually a good combination for equities.” This creates an environment for an equity rotation away from more defensive bond proxies and in favor of more volatile shares that are sensitive to economic growth. Financial and energy sectors have roared ahead in September, leaving the likes of real estate, healthcare and utilities behind.
Eaton Vance, Wells Capital Management and GW&K Investment Management are among the funds that have picked up cyclical and value stocks this month. Just like bonds, growth and momentum stocks had gotten "too expensive” and this is a "healthy correction, ” said Dan Miller, a director of equities at the $40-billion GW&K.
"If we do see growth expectations improve a little and inflation expectations firm a little, that could lead to an environment where yields rise and equity markets still tread water or help us touch new highs, ” said Brian Jacobsen, a multi-asset strategist at Wells Capital Management. - Bloomberg
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