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Equity investors should make no mistake: higher bond yields are a threat to future returns and this is particularly true for dividend and income-focused portfolios. The question is when or if rates will require a re-allocation of holdings.

Citi global strategist Robert Buckland’s most recent research report, Rising Real Yields: What to Do, detailed the importance of inflation-adjusted (real) U.S. bond yields for equity valuations. He noted that U.S. real yields fell from 1.2 per cent in early 2019 to negative 1.1 per cent at the end of 2020.

The decline in yields helped the MSCI All Country World Index generate an impressive 44 per cent return for the period. With bonds carrying an unattractive negative real yield, global investors moved to stocks, pushing prices higher.

Real yields have now moved closer to positive territory, from minus 1.0 per cent to minus 0.6 per cent. Mr. Buckland believes that a move to zero per cent would force global stocks to re-rate lower, from the current 20 times earnings to 17 times. This implies a painful decline of 15 per cent for the World index.

Rising yields do not threaten all equity sectors equally. Mr. Buckland is most concerned about a sharp correction for high growth areas like electric vehicles and renewable power. Andrew Garthwaite, global strategist at Credit Suisse, warned clients that the dividend-heavy real estate, utilities and beverages stocks are likely to underperform in a higher rate environment while global banks, diversified financials and auto-related stocks should climb with rates.

Economically-sensitive market sectors like industrials, materials and energy have historically outperformed as rates and inflation pressure build. Along with banks and financials, these sectors make up the bulk of the TSX, making it well-positioned to outperform in a rising rate environment.

For investors in sectors negatively affected by rising yields, there are two danger signals to watch. Mr. Buckland’s view implies that markets will become volatile as real 10-year yields approach zero (this can be followed using ten-year Treasury Inflation Protected Securities’ yields here). Mr. Garthwaite believes equity markets will react negatively to nominal (not inflation-adjusted) 10-year Treasury yields, currently 1.42 per cent, rising to above 2.0 per cent.

-- Scott Barlow, Globe and Mail market strategist

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Stocks to ponder

Bridgemarq Real Estate Services (BRE-T) Toronto-based Bridgemarq, previously known as Brookfield Real Estate Services, is a provider of real estate services offered through three main banners: Royal LePage, Quebec-based Via Capitale, and Ontario-based Johnston & Daniel. The small-cap stock is thinly traded and is not covered by any analysts. It has a dividend yield of 8.7 per cent, and its CEO believes that the fundamentals driving its business are strong. Jennifer Dowty has this profile of the company.

The Rundown

Recent ‘junk rally’ takes speculative stocks higher in bet on economic growth

With an economic boom for the ages shaping up, markets are seeing a pro-cyclical rotation on steroids. And rather oddly, investors are turning against companies reporting good news. For the first time in more than a decade, S&P 500 companies beating revenue and earnings estimates in fourth-quarter results have underperformed the market on the day of their announcements. Tim Shufelt reports.

As inflation brews, it is becoming treacherous times for investors. Here’s the best strategy moving forward

Inflation hasn’t been a major concern for years, but that idyllic scenario may be ending. Gordon Pape has some thoughts on how investors should prepare their portfolios for what comes next.

Emerging markets feel the heat of the ‘bondfire’

Just when developing economies were ready to bask in the post-COVID rebound in global growth, in sweeps a bond market blaze to scorch them again. Most major investment banks were predicting a stellar 2021 for emerging market assets as long as one crucial snag - global borrowing costs rising too fast - was avoided. Well guess what, they are on a tear. Marc Jones and Tom Arnold look at the new challenges facing investors in emerging markets.

SPACs turn to ‘stonks’ as amateur traders take on more risk

An army of amateur traders that has fuelled a rally in heavily shorted stocks, or “stonks,” such as GameStop Corp, has discovered the arcane world of SPACs. They are hearing about their obscure stock market tickers on social media, from TikTok to Twitter, and placing risky bets. Although all stock investments involve risk, many companies going public by merging with a SPAC take risk to another level because they often are years away from generating revenues when they go public. Joshua Franklin and Krystal Hu of Reuters report.

Bulls run wild: Chinese funds throw more fuel on copper’s flames

Copper punched through the $9,000-per tonne level last week for the first time since 2011, with a red-hot rally showing no signs of abating. While the copper market has risen for 11 consecutive months fuelled by China’s physical buying and the narrative of a metals-heavy global green recovery, Chinese funds stepped into the driving seat last week with one player placing a mega $1-billion bet on higher prices. As Andy Home reports, market pros aren’t willing to bet against copper even as the metal nears all-time highs.

Others (for subscribers)

The most oversold and overbought stocks on the TSX

Monday’s analyst upgrades and downgrades

Monday’s Insider Report: Trustee is buying this high-yielding REIT that’s hiked its distribution every year

Globe Advisor

Financials may be a silver lining in bond market rout

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Ask Globe Investor

Question: I have a few mutual funds in my RRSP portfolio with a total accrued value of $37,000. I have owned them for the past 15 years. The MER for these funds range from 1.71 per cent - 2.71 per cent. The average for the five funds is 2.32 per cent. These funds have good returns.

Given the high MERs associated with these funds, I am considering cashing in and purchasing ETFs within my RRSP portfolio. Do you think this would a good move? Also, I am 64 years old and retired. What type of ETFs would you recommend? I do not have a company pension plan.

Answer: You are proposing to sell funds with good returns to buy cheaper ETFs. This could be a case of penny-wise, pound-foolish. You don’t say what the returns are, but you need to put them in context with what you are paying. You could end up with ETFs that cost less but don’t perform as well. I suggest you look at the returns of ETFs that may interest you and compare their returns over the long term with those of your mutual funds.

As for which ETFs to buy, if you go that route, look for those at the lower end of the risk scale. Since you have no pension plan, your RRSP may be the main source of your retirement income, so you don’t want to take unnecessary chances with it.

--Gordon Pape

What’s up in the days ahead

David Berman analyzes bank stocks’ reaction to earnings season and finds the smaller names with more perceived exposure to loan losses have rallied the most. He’ll explain why.

Click here to see the Globe Investor earnings and economic news calendar.

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Compiled by Globe Investor Staff