Bond yield rises

The “taperless” tantrum in the bond market continues.

Our long run view is that rates have a structural, secular set of forces pushing them lower (effectively demographics, amongst some other things) with a powerful set of cyclical factors pushing them upwards (the pandemic ending, US fiscal policy).

The equity market can handle higher yields. What it doesn’t like is yields rising too fast, because “too fast” feels too close to “uncontrolled”. And the market hates uncertainty.

So far, developed equity markets have held up reasonably well, given the prevailing view that yields are rising because of a) higher growth expectations (which the market views as a good proxy for higher future corporate profits) and b) less threatening that normal because the higher yields don’t herald a tightening of monetary conditions (meaning the Fed commitment to Average Inflation targeting is viewed as “credible”).

So far, the emerging markets have held up reasonably well, which is quite different to the previous taper tantrum, in which both emerging market risky assets, and EM currencies, sold off hard.

However, we don’t think, should rates push much higher, that this can last.

As such, we are considering a trim down of some of our passive EM holdings (we hold an EM ETF across our diversified portfolios, at a 12.5% sub-asset class weight – on a DAA basis this is about 2.7% of a Balanced portfolio).

We are also considering a further modest trimming of our overall equity exposure.

We say “modest” above, and are being a lot more hesitant than normal, because

• we are underweight commodities, which have done very well, and given supply dynamics (tight supply due to COVID related disruptions) could well go higher
• the tight demand dynamics, which, thanks to US fiscal policy, means US GDP growth could absolutely ignite over 2021/2022, would have positive spill over effects into global growth and into other asset classes
• this applies to emerging markets too.

This means we are reluctant to take too much of our growth exposure (which comes from equities) off the table. The damage that can be done from a portfolio compounding away from you is not immaterial, and consequently, the decision to market time / asset allocate away from one’s strategic weights is more pronounced than it normally is.

Also in the mix of decisions is the overweight to alternatives. They’ve done well, providing an alternative to cash that has generated low-to-no correlation positive returns. However, as yields climb towards that two handle, the attraction of switching back grows.

Given our longer run view that rates will remain lower for longer, and have a deflationary bias, our goal is to eventually close out our underweight to fixed income, and move back overweight with a long duration bias.