The final week of February left investors with a foretaste of what might occur if central banks were to switch to tightening. The correction hitting major market indices was triggered by the swift rise in long-term yields, which on the US 10-year bond temporarily spiked upwards of 1.6%. That was even higher than the dividend yield of S&P 500 companies (1.5%). If this move persists, it could render equities less appealing, especially considering their stretched multiples at the moment.

Taken in isolation, higher long-term interest rates are not necessarily a bad thing. The question is whether this marks the end of a period of price stability following several failed attempts by central banks to spark inflation. Does this signal reversion to a potential hazardous bout of inflation or does it reflect – as we believe it does – increased confidence in the resilience of economic growth? This second assumption is substantiated by the intense rotation among sectors in equity markets with cyclicals such as basic materials, oil & gas and financials back in the spotlight. Notably, the US banks index has returned to its pre-financial crisis level, having gained 20% in February. Growth stocks had been trading on pricey multiples and were correspondingly hit hard, especially tech. But we think this will be temporary. It has also given rise to some opportunities to buy tech stocks. The sector has firm prospects thanks to the long-run growth of cloud storage, e-commerce, digital
advertising and the advent of 5G.

More or less everywhere, from Asia to Europe and over to the US, central banks have made it clear that financing conditions will stay loose and support measures will remain in place. This news has been enough to put markets back on a more even kilter. For example, Fed boss Jerome Powell has stated that the US economy still lies a long way from its full employment and 2% inflation targets. The ECB will continue to care for economies in Europe, where the pandemic is not sufficiently under control for a total lifting of restrictions.

In the US, GDP looks set for a boost from the FDA’s green light for Johnson&Johnson’s vaccine, which will help bring the novel coronavirus under control, and Joe Biden’s stimulus drive, which could receive Senate approval in mid-March. Forecasts suggests 7-8% GDP growth this year, even in the case where the fiscal jab is reduced from the planned USD 1.9 trillion to USD 1.4 trillion. In Europe, growth in manufacturing output picked up pace, as attested to by a PMI at 57.9 – the best score in three years. This spells good news for the earnings outlook. Corporate profits are set to expand by 30% in 2021 and 20% by 2022.

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