Despatches  

Equities can bounce back, despite higher rates

Equities can bounce back, despite higher rates
 Anna Nekra/Pexels

Although bond yields are rising, the likelihood is they will remain negative in real terms, meaning investors may turn back to equities, according to Matthew Cady, investment strategist at Brooks Macdonald.

The start of 2022 has been marked by investors selling off bonds, which means the price falling and the yield rising, on fears that inflation will rise, making the value of the fixed income from the bonds worth less. 

That has had a knock-on effect in other markets, with those equities, such as in the technology sector, which do not pay a dividend, also falling sharply in value, as part of a wider sell-off.

Technology shares are particularly vulnerable as in many cases they do not pay a yield now, and a higher yield from the bonds means investors can get a guaranteed higher income now, rather than hoping for a higher return from non-dividend paying equities in future.

Cady said the low bond yields that have been a feature of the past decade mean investors were forced to allocate more to equities, as “there was no alternative.”

The higher yields of recent months may have created something of an alternative for investors, but Cady believed it could be short-lived.

He said this was because while yields were rising, they were likely to remain below the rate of inflation, and thus be negative in real terms, that is, the spending power of the fixed income will be diminishing. He felt this could prompt investors to start buying equities again, as they may have a better chance of offering protection against inflation.

He said: “Whilst there are competing forces at work within equities, between growth/defensive and value/cyclical investment styles, at a higher asset allocation level between equities, bonds, and cash, there continues to be a clear and consistent message.

"Across equity markets globally, with an equity earnings yield well in excess of the yield available on bonds and cash, there is a clear relative preference for investors. Frequently expressed as TINA (There Is No Alternative), equities are distinguished by the fact that expected real returns (using longer-term inflation expectations) are still positive.

"With expected real yields on government bonds firmly negative, should there be a reallocation of assets away from stockpiled cash, this could be positive for the balance between demand and supply across risk assets, and would be expected to favour equities in particular.”

Cady added that while equity markets have performed weakly in recent weeks, when companies have produced higher than expected profits, the share prices have gone up, indicating that investors were not “exhausted” with equities. He added that companies have generally been achieving their forecasted profits for this year so far. 

david.thorpe@ft.com