What are bond yields telling us?
Bond yields fell to record low levels in the depths of the COVID-19 downturn in March and remain there – G7 and Australian 10-year yields are 0.4% and 0.9% respectively – despite powerful equity market rallies and rebounding key leading indicators. In 2009, 2012 and 2016 bond yields rose when equities rallied and growth indicators strengthened (Figure 1). So who is right, bonds or equities?
We present three possible explanations for this apparent market disconnect:
- A W-shaped recovery: second waves and/or poor policy leads to a double-dip recession – bonds are right, equities will sell-off.
- Equities are overvalued: the market rebound and COVID-19 driven profit declines have pushed valuations to unusually high levels. Markets are discounting U-shaped GDP and earnings recoveries, with earnings back at pre-COVID-19 levels in 2022. If this proves too optimistic, bonds will prove right and equities sell-off.
- Ultra-aggressive central banks: the unprecedented mix of zero rates, aggressive balance sheet expansion, and strong forward guidance means bond yields can stay low – they are priced to policy – while equities can rally – they are priced to recovery.
At an asset class level, bonds should only perform in a W-cycle downturn. We do not expect a W and are underweight bonds. Equities benefit from the record low discount rate, low cost debt and central bank asset price support.
Download the Full Report below for the Twelve stocks set to benefit from low rates in a V-shaped recovery.
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