March 9, 2021
I have good news for you.
After a year like the last, I know that simple good news sounds terribly enticing, so let’s get right to the point: the 10-year bond yield has gone up.
You probably have some confetti in your desk drawer (who doesn’t have one, right?), So take a moment to toss a few in the air to create a little party just for the sake of it. you. Savor this moment.
Perhaps the global rise in bond yields is not an exciting prospect, with a potentially fatal pandemic eroding our sense that we may one day reach something that looks like normal again, but be aware of this: rising prices. bond yields could be sign that at least one thing is returning to normal, the economy.
Rising 10-year interest rates probably won’t be fantastic news for some bond investors, as many bonds lose value as interest rates rise. But now that rates have hit a year-over-year high, we can safely assume that bullish investor expectations and bullish corporate earnings estimates are having a positive impact on the economy.
As you clean up the celebratory mess you just made on your desk, remember that the reason for your confetti-strewn workspace is because the positive feedback loop of private sector confidence and a stronger economic outlook. seems to have started.
Are inflation fears inflated?
As political policy on the next COVID relief plan intensifies, much will be made of the possible inflationary impact of so much government spending in such a short period of time. The next relief plan, as you’ve no doubt heard by now, comes at a price of $ 1.9 trillion, and it comes just after the nearly $ 4 trillion spent on relief in 2020 ($ 3 trillion). billion dollars in March 2020 and another 900 billion dollars). later this year).
While bond markets appear to be sketching a bullish story for the U.S. economy, some investors fear that an overheated economy could push the Federal Reserve to raise rates earlier than expected, which would effectively trigger the sprinkler system and drain the water. Party.
Big bank prognosticators
Today, at least, some big banks are not sounding the alarm bells about the risk of inflation being too high above the Federal Reserve’s current target of 2%.
UBS economist Alan Detmeister believes that the effect of the bill on inflation will be “likely small” with a gradual increase in prices over the next few years while Jan Hatzius of Goldman Sachs also believes that the risk inflation is limited.
Compare this outlook with that of the head of the US economy, Michelle Meyer, who suggests that the question is not whether or not the economy will overheat, but rather to what extent.
Bank of America predicts GDP growth of around 6% in 2021 and 4.5% in 2022, which is stronger economic growth than we have seen for many years, and the adoption of the next project A relief law could increase the difference between maximum potential GDP growth and real GDP (output gap) to its highest level since 1973.
And Deutsche Bank’s chief international strategist Alan Ruskin notes that inflation often lags growth for up to two years, suggesting signs of inflation seen today may not materialize. (or become a threat, depending on your market position) before 2022 or later.
Inflation and the markets (or what that means to you)
Historical analyzes should never be confused with investment advice or even predictive indicators, but investors would certainly do well to consider the impact of higher inflationary environments on various asset classes.
If this sort of thing piques your interest (and why not?), Then the 48-year-old from 1970 to 2017 can give us some clues.
Using the median level of inflation over this period of 3.26%, we can reasonably characterize the first 24 years as a period of high inflation and the last 24 years as a period of low inflation.
Tracking the returns of various asset classes after accounting for inflation, “real returns”, shows clear indications of winners and losers in high or low inflationary environments.
Asset classes in times of low inflation
Over the last 24 years of the period, the following asset classes performed quite well in a low inflation environment: US small cap stocks (11.44%), US large cap stocks (10.8%) , real estate (10.3%), non-US equities (8.67%) and US bonds (4.27%). US bonds fared better in a low inflation environment compared to a high inflation environment, so I would consider that as “outperformance”.
It’s easy to see why companies that can borrow money at lower interest rates might perform better in times of low inflation (large cap and small cap stocks), and real estate as a class. assets also benefits from the same principle.
Commodities (-4.03%) and US cash (0.41) were the worst performers during the same period.
Asset classes in times of high inflation
Now take a look at how asset classes performed in a high inflationary environment over the 24 years from 1970. Commodities lead the pack by far with an average annual growth rate of 15.13% and US cash outperforms (1.33%) while most other asset classes show much slower growth, real estate (7.86%), US small cap stocks (6.26%), non-US stocks ( 5.21%), US large cap stocks (4.7%) and US bonds (3%).
What to do?
I can’t tell you what to do about all of this because I don’t know your specific financial situation, of course, but I can tell you that in 2003 and 2009, the profits of companies at the start of these takeovers drastically increased. rebounded. Consensus forecasts, as noted by Societe Generale, point to a 30% increase in profits for companies in the international index and a 40% increase for emerging markets.
If these forecasts are correct, then stocks may have to climb further before inflation, if it sets in even modestly, could wipe out some of these gains.
Anthony M. Conte is a Managing Partner at Camp Hill-based Conte Wealth Advisors. He can be contacted at [email protected]
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