Just because bond yields and interest rates are rising doesn’t mean stocks can’t do well in that environment.
But it’s the type of stocks investors need to know to stick with or buy, and which ones to reduce or eliminate exposure to in order to protect investment returns.
Here are some research hi-lights and illustrative charts detailing why investors should overweight certain kinds of equities over the next 12 months.
- Real government bond yields have increased in recent weeks, which could put further downward pressure on equity prices in the near term.
- Nevertheless, we continue to advocate overweighting equities over a 12-month horizon.
- Historically, rising real yields have been most toxic for stocks when yields have increased in response to hawkish central bank rhetoric. This is manifestly not the case today.
- The Fed’s accommodative stance should limit any near-term upward pressure on the US dollar.
Investors should favor cyclical and value-oriented stocks over defensive and growth-geared plays.
As we pointed out two weeks ago, rising real yields have historically been most toxic for stocks when yields have increased in response to hawkish central bank rhetoric.
This is manifestly not the case today.
In his testimony to Congress this week, Jay Powell downplayed inflation risks, stressing that the US economy was “a long way” from the Fed’s goals.
He pledged to tread “carefully and patiently” and give “a lot of advance warning” before beginning the process of normalizing monetary policy.
We expect the 10-year Treasury yield to stabilize in the 1.6%-to-1.7% range, still well below the level that would threaten the health of the economy.
Favour Cyclical And Value-Oriented Stocks In A Weaker Dollar Environment
The Fed’s accommodative stance should limit any near-term upward pressure on the US dollar.
Whereas stocks are most sensitive to absolute changes in long-term real bond yields, the dollar is more sensitive to changes in short-term real rate differentials with US trading partners.
Since the Fed is unlikely to tighten monetary policy anytime soon, US short-term real rates could fall further as inflation rises.
- Cyclical stocks, which are overrepresented outside the US, tend to benefit the most from strengthening global growth and a weakening dollar.
- Value stocks also generally do well in a weak dollar-strong growth environment (Chart 7).
- Bank shares – which are concentrated in value indices – typically outperform when long-term bond yields are rising (Chart 8).
In contrast, as relatively long-duration assets, growth stocks often struggle when bond yields go up.
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