Is the bond market smarter than the stock market?

John Leiper – Chief Investment Officer – 25th November 2020

Following on from last week’s blog, the dramatic rotation from growth to value remains in place for now. Early signs of a quick snapback into the prior channel have not yet materialised and instead the ratio has consolidated and even shown signs of moving lower.

On mobile: review detail in landscape mode

Equity markets have demonstrated the most enthusiasm for rotation. Prior losers, such as the FTSE 100 and Stoxx Europe 600 have surged ahead versus the S&P 500 where leading sectors such as information technology and consumer discretionary have given way to more cyclical sectors such as industrials and materials. Financials and consumer staples have also improved notably over the last month, transitioning from market laggards, to near market leaders.  

On mobile: review detail in landscape mode

We’ve taken a number of steps over the last week to participate in this developing narrative by reducing exposure to the quality factor and increasing exposure to US industrials which stand to benefit from increased infrastructure spending in the aftermath of the US election. Since inception the trade has posted positive relative returns.

On mobile: review detail in landscape mode

In last week’s blog, I suggested that for the rotation to have legs we would need to see higher bond yields. However, bond markets seem far from convinced.

In fact, long-dated Treasuries, which originally sold-off, promptly reversed course and have since rallied back above upper resistance in yellow. This pause in the trend towards a steeper yield curve can be explained by short term factors and I retain my forecast for a steeper yield curve in 2021. These factors include the surge in new coronavirus cases, increased likelihood of lockdown (hitting GDP numbers in Q4) and the diminished likelihood of a new fiscal package before the Georgia senate run-off in early January.   

On mobile: review detail in landscape mode

It was a similar story for high yield bonds which declined to follow US small caps higher, despite their cosy and long-established correlation.

On mobile: review detail in landscape mode

An old wall street saying asserts that the bond market is smarter than the stock market. If that’s true, it might prove prudent to exercise some caution, which is why I’d rather ease into the rotation trade, at the expense of short-term underperformance, than go all-in. That said, if its conviction we’re looking for, we might be looking in the wrong place.

When we talk about the US dollar, it’s usually in reference to the dollar index, which represents a basket of developed market currencies, dominated by the euro (which makes up over half the index weight). At the time of writing this index is at key technical support, flirting with its weakest level since April 2018. Should the dollar break through this level it could catalyse the next leg of the ongoing rotation trade.

On mobile: review detail in landscape mode

There has also been clear US dollar weakness against Asian currencies, as demonstrated by the Bloomberg JP Morgan Asia Dollar index which has risen to its highest level since June 2018. This is due to a variety of factors including better containment of the virus and a strong economic rebound across the region, led by China.

On mobile: review detail in landscape mode

In The Call-Up, published late September, I wrote:

depending on the progression of the virus, we remain open to the possibility of a broader economic recovery, improvement in risk sentiment and subsequent rotation into cyclical investment opportunities. Such opportunities exist within the broader emerging market currency index which continues to lag developed market peers… by around 15% versus the US dollar”.

Since then we have seen a notable rally across emerging market currencies (a fall in the redline represents stronger EM and a weaker US dollar) even as the developed market US dollar index has gone sideways. What I find particularly interesting is the initial catalyst for this move was not news of a vaccine, but the US election. This is consistent with the prevailing view that a Joe Biden victory is good for EMs, primarily through global trade growth which should improve relative to Trump’s more protectionist stance.

On mobile: review detail in landscape mode

The portfolios have benefited from this over the last few months given our overweight allocation to emerging market currencies with unhedged exposure to the Chinese renminbi, South Korean won and Taiwanese dollar.

However, recent gains have increasingly been driven by non-Asian currencies such as the Brazilian real, Mexican peso and South African rand. This rotation, towards EM value, is consistent with what we are seeing in developed market equities and my belief that we will see a strong cyclical recovery across emerging markets in 2021. Key drivers include rising support from external demand (driven by a widening US current account deficit, low US real yields and a weaker dollar) as well as China’s reflationary growth impulse and the lagged effects of prior accommodative domestic policies.

The prevailing narrative is China, first and foremost, and East Asia more generally, has come through the pandemic far better, both medically and economically, than other regions. Meanwhile, there is a second group of EM countries which have suffered far more, in both regards, and their markets have suffered accordingly. The conundrum is whilst East Asia is driving the recovery, and may continue to do so for some time, asset valuations are far higher relative to economically sensitive EM value stocks which look especially cheap and could outperform if a vaccine proves effective. EM economic growth is already showing signs of gaining momentum and EM ex China has the greatest potential to catch-up with the rest of the pack. From a vaccine perspective, the game changer for these countries wasn’t Pfizer/BioNTech or Moderna but Monday’s announcement from Oxford University / AstraZenca – whose vaccine is more conventional, easily storable and cost effective, with an admirable efficacy rate.

Within EM value, undervalued commodity currencies, such as the Brazilian real, stand to benefit from a pick-up in commodity prices driven by ongoing US dollar weakness.

On mobile: review detail in landscape mode

Another notable opportunity is Russia, which has seen the rouble flounder against the US dollar whilst other currencies have strengthened. This can be explained by escalating coronavirus infections and the currency’s high correlation to oil prices. It is my belief that ongoing steps towards an eventual vaccine could end that underperformance, particularly if energy prices start to participate in the commodity rally. The Russian equity market is a true EM value play via its high exposure to natural resource companies like Lukoil and Norilsk Nickel, and financials, like Sberbank, which benefits from a steeper yield curve compared to mature economies.

On mobile: review detail in landscape mode

Finally, a few words on Brexit, given the US dollar has fallen to 1.33 against the UK pound. Whilst no-deal remains a clear risk, the UK seems to be moving ever closer to some kind of a deal as signalled by the recent break above the 6-year resistance line in yellow. If a deal is achieved, we could see the currency rally towards its long-term moving average in the mid-1.50s by the end of 2021. 

On mobile: review detail in landscape mode

This investment Blog is published and provided for informational purposes only. The information in the Blog constitutes the author’s own opinions. None of the information contained in the Blog constitutes a recommendation that any particular investment strategy is suitable for any specific person. Source of data: Bloomberg, Tavistock Wealth Limited unless otherwise stated.  

Want to know more about the Equity Markets?

Please contact us here:

1 + 13 =

Recent blogs
Since the Market Low

Since the Market Low

The ACUMEN Portfolios continued their strong run throughout October, largely outperforming the market composite benchmark and IA sectors (used for peer group comparison purposes) which lost ground across the board.

read more
Canary in the Vol-Mine

Canary in the Vol-Mine

With the US election just 8 days away, financial markets are following the polls and pricing in a Biden win. The prospect for a Democratic clean sweep has contributed to the rising ‘Blue Wave’ narrative benefiting those companies that stand to benefit from Democratic party policy. 

read more
Further For Longer

Further For Longer

On Tuesday Fed Chairman, Jerome Powell, made a speech at the National Association for Business Economics, during which he implied the government should err on the side of caution and provide too much stimulus rather than too little. 

read more
Smart Beta Unwrapped

Smart Beta Unwrapped

Our Chief Investment Officer, John Leiper, was recently invited to provide his valuable insights as part of ETF Stream’s video conference livestream: “Beyond Beta Europe Digital: Smart beta unwrapped”.

read more
Life Imitating Art

Life Imitating Art

Saturday Night Live has a reputation for expertly parodying presidential election debates. My all-time favourite is Al Gore (Darrell Hammond) versus George Bush (Will Ferrell) and this year didn’t disappoint with expert performances from Donald Trump (Alec Baldwin) and Joe Biden (Jim Carrey).

read more
Emerging Markets: ETF Stream

Emerging Markets: ETF Stream

Our Chief Investment Officer, John Leiper, was recently invited to provide his valuable insights into emerging markets as part of ETF Stream’s video conference livestream: “Big Call: Emerging Markets”.

read more
The Call-Up

The Call-Up

Last week the FTSE Russell decided to include Chinese government bonds in its flagship World Government Bond Index (WGBI). The decision follows similar moves, from JP Morgan and Bloomberg, and a failed attempt to do so just one year prior which resulted in a number of reforms, to increase accessibility and currency trading options, that ultimately paved the way for benchmark admission.

read more
Technical Perspectives

Technical Perspectives

In last week’s blog we discussed the ‘Nasdaq whale’, Softbank, and the role it played, alongside an army of retail investors, driving tech prices ever higher prior to the recent correction. These short-term ‘technical’ flows are driven by the options market as traders look to hedge their underlying exposure, amplifying moves both lower and higher.

read more
A Speech For The History Books

A Speech For The History Books

In a speech for the history books, last week Fed chairman Jerome Powell announced a significant change to the way it conducts monetary policy by formally announcing ‘average inflation targeting’.

read more
Room to Run

Room to Run

Despite the fact the coronavirus has plunged many countries into recession, global equity markets are now back at all-time highs, as measured by the Bloomberg World Exchange Market Capitalisation index.

read more
Rising Phoenix

Rising Phoenix

In The Return Of Inflation (5th June 2020) we made the case for a transition from the existing deflationary narrative to one in which markets start to price-in inflation.

read more
All That Glitters…

All That Glitters…

The US dollar index, which represents the value of the dollar against a basket of developed market peers, fell through key technical support to its lowest level in 2 years.

read more
Q3 2020 Quarterly Perspectives

Q3 2020 Quarterly Perspectives

Despite suffering the worst pandemic in over a century, and the sharpest economic contraction since the second world war, global equity and bond markets staged one of the fastest recoveries of all time in Q2.

read more
The Return of Inflation

The Return of Inflation

Quantitative easing, or QE, is where a central bank creates money to buy bonds. The goal is to keep interest rates low and to stimulate the economy during periods of economic stress.

read more
The Powell Pivot 2.0

The Powell Pivot 2.0

In January 2019 Jerome Powell pivoted from a policy of interest rate increases and balance sheet cuts to interest rate cuts and, later that year, balance sheet expansion.

read more
Don’t Fight The Fed

Don’t Fight The Fed

Over the last decade, the Fed has increasingly resorted to unconventional monetary policy, such as quantitative easing, or QE, to stimulate the economy.

read more
Super Contango

Super Contango

In an unprecedented day in the history of oil trading the price of the front month contract for West Texas Intermediate (WTI) oil fell below zero to -$37.63.

read more
The beginning of the end?

The beginning of the end?

The coronavirus has brought economic activity to a virtual stand-still and transformed a strong global economy, with lots of debt, to a weak economy… with lots of debt.

read more
Halcyon Days

Halcyon Days

Today, global equity markets have fallen again and yields on developed market government bonds have collapsed even further. In my opinion, there are two diametrically opposed events playing out at the same time.

read more
A Time to Remain Calm

A Time to Remain Calm

This is a time to remain calm, patient and focused on fundamentals whilst relying on sound risk management practices. Over the last week the number of confirmed cases of COVID-19 has risen to more than 83,000 people across 50 countries.

read more
ESG in the Spotlight

ESG in the Spotlight

Environmental, social and governance (ESG), a byword for sustainability, has in recent weeks occupied rarefied real estate on the landing page of several finance industry titans.

read more