Daily roundup of research and analysis from The Globe and Mail’s market strategist Scott Barlow
Every few months I read a research report that’s undeniably important, and BofA Securities’ Michael Hartnett’s Trading the Inflation Theme published Thursday is one of those (my emphasis),
“2020 marked the secular low point for inflation and interest rates; new central bank mandates, excess fiscal stimulus including UBI, less globalization, fading deflation from disruption, demographics, debt…we believe inflation rises in the 2020s and the 40-year bull market in bonds is over… BofA Global Research’s Inflation Survey shows 61% of analysts saw their companies raise prices in recent months . AA [asset allocation] implications bullish real assets, commodities, volatility, small cap value, and bearish bonds, US$, large cap growth.”
Rising yields have been forecast before, but this time the analyst survey shows that it’s already happening, not a potential event. No pre-retirement investors are experienced in dealing with a market backdrop of steadily rising rates so this is a huge change. I intend to flesh out the profound implications (if he’s right, of course) in a column next week.
“@SBarlow_ROB BoA: “we believe inflation rises in the 2020s and the 40-year bull market in bonds in over.”” – (research excerpt) Twitter
Morgan Stanley strategist Ryan Hammond fleshed out how rising rates are already affecting portofolios,
“The move higher in interest rates continues to ripple through the equity market. The nominal 10-year US Treasury yield surged by 39 bp between February 10 and 25, driven entirely by real yields, and rose by an additional 5 bp last week, before slipping by 7 bp early this week. Between February 10 and March 4, the S&P 500 fell by 4%. Historically, the S&P 500 has typically struggled to digest rate moves of more than 2 standard deviations in a given month. Indeed, the recent surge in nominal and real yields were both 3 standard deviation events … Below the surface, the surge in bond yields has particularly weighed on long-duration Growth strategies. As rates fall, the value of distant cash flows become more valuable, consistent with the sharp outperformance of Growth last year. However, as we previously showed, investors pay more for near-term growth and less for long-term growth as rates rise. Between February 10 and March 8, Russell 1000 Growth declined by 9%, a basket of non-profitable tech stocks fell by 25%, and Russell 1000 Value rallied by 3%.”
“@SBarlow_ROB MS: “Historically, the S&P 500 has typically struggled to digest rate moves of more than 2 standard deviations in a given month”' – (research excerpt) Twitter
There are potential sources of market volatility buried deeply in the plumbing of the U.S. credit markets that could bite all investors next month,
“In April 2020, the Fed provided an exemption to banks for calculating their Supplementary Leverage Ratio (SLR) by excluding Treasuries and reserves held at the Fed from being included in the denominator of the SLR… This was a much-needed exemption as it prevented banks from becoming balance sheet constrained as excess reserves grew due to QE and other Fed programs… The growth in reserves will create significant leverage constraints for banks if the SLR exemption is not extended. Note that ultimately it is the Fed that determines the level of reserves held in the banking system as a whole (and indirectly, the Treasury through changes in the their cash balance). Reserves are highly concentrated, with large institutions holding the vast majority of reserves in the banking system. Banks have put reserves to work over the past year by adding $309bn in Treasuries and $540bn in MBS onto their balance sheets since COVID began (Figure 2). Further growth in reserves will leave banks with additional cash to invest, but a failure to extend the SLR exemption would sharply lower banks’ SLR ratios, creating the need for them to hold additional capital.”
In short, a policy change would sharply reduce market liquidity.
“@SBarlow_ROB Important SLR ‘splainer from TD” – (research excerpt) Twitter
Diversion: “Your Next Office Might Be a 3D-Printed Smurf House” – Gizmodo
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