deVere Investor Insight - Q1 2021

Investor Insight // Q1 - 2021 39 But not all sectors respond in the same way, and two areas -tech and ‘bond proxies’- are less secure than the broad swath of economically sensitive cyclical sectors, that tend to dominate most major stock markets. Many tech and growth stocks promise ‘jam tomorrow’, but in the meantime demand large quantities of capital to enable them to reach profitability. They are vulnerable to relative underperformance as bond yields rise. This is because the opportunity cost for investors to hold such ‘long duration’ stocks increases, as the risk-free rate of return (i.e., that available from government bond) rises. At the other end of the spectrum are high dividend-paying stocks that deliver plenty of jam today, because there is little opportunity for growth through re-investing the profits. Think, perhaps, of utilities and insurers. These became attractive to income seekers over the last decade as yields on government bonds shrank. But as bond yields rise, might capital flow out of these high dividend paying stocks and back into bonds? However, for much of the rest of the stock market, the recent bout of nervousness on bond markets has been treated as good news since fear of inflation is confirmation that the coming global economic recovery will be strong. This in turn justifies the almost year-long rally in stocks that began in late March 2020. Initially led by tech and other Covid-19 ‘winners’, since November it has been driven by expectations of strong year-on-year profits growth. Investors in economically sensitive cyclical stocks, such as mining, financials, industrials and travel, are particularly excited over the prospects for 2021. Since 2009 we have had several tantrums in the U.S Treasury market, during which bond investors speculated that inflation is about to be unleashed. It hasn’t happened. Instead, long-term deflationary factors gain the upper hand. These include the aging of western societies (which reduces demand), a lack of investment (which helps drives innovation and future growth), globalisation of the labour supply, and excess savings in Asia and large parts of Europe. The great bond market rally that began in the early 1980s may be coming to an end, after yields fell to extraordinary low levels last year. But a great reversal appears very unlikely.