In recent weeks, we have heard so much about the rising US Treasury bond yields and growing inflation expectations that have led to concerns about market volatility. This has been compounded by worries that US President Joe Biden’s US$1.9 trillion (RM7.8 trillion) stimulus package may spur inflationary pressure, prompting the central bank to raise interest rates.
This is viewed as bad news, especially in the light of the recovery underway. For example, for corporates tapping into the debt markets, investors would expect higher compensation to take on the corresponding levels of risk. Corporates facing a bottleneck in financing due to higher costs would inevitably slow down their recovery pace, delaying expansion plans and possibly weighing on earnings. These are all major detractors to the equities space.
Again, while the reasoning is sound, we don’t view this as reason enough to disengage from equities now. The rising US Treasury yields, as we see it, is a function of money moving out of safe Treasury bills and into risk assets as investors grow more optimistic about the future. Real yields (yields after accounting for inflation) are still deep in negative territory.
In fact, once investors’ optimism is affirmed by an earnings recovery, risk assets such as equities and bonds will be well positioned to benefit from the global recovery from the pandemic in 2021. In the meantime, it is wise to be sceptical about any unrealistic increase in equity prices and invest for the long term.
Recent minutes from meetings of the US Federal Reserve also show continued misgivings over a fast-paced US economic recovery, which means interest rates and asset purchase programmes (quantitative easing), where the Fed dumps copious amounts of money into the US economy, will continue unabated at the very least until the end of this year. And that will be supportive of risk assets.
We believe concerns about high inflation, and therefore the withdrawal of monetary policy support, is premature. The Fed is likely to stay very dovish in the foreseeable future in view of the stalling labour market recovery. High unemployment and declining labour participation rates suggest plenty of slack in the economy, which should contain inflationary pressure. Rising prices of commodities from the lows in 2020 could drive a temporary rise in prices but, over the longer term, inflation is estimated to remain well within the expectations of the US central bank.
Cyclical and value sectors are the beneficiaries as vaccine rollouts increase investors’ confidence of a gradual push towards a reopening of economies. The energy, financial, industrial, materials and real estate sectors have seen a boost since the rotation out of the technology sector. Although tech stocks have suffered some losses, as we have seen in the past few weeks, we still believe this sector will be a long-term driver of growth.
As the coronavirus crisis fades, retail real estate investment trusts (REITs) should also benefit, given that this sector struggled last year during the lockdown as most malls and non-essential retailers were badly affected. With the relaxation of movement restrictions and the reopening of businesses once Covid-19 recedes more fully, it will be good news for the retail REITs as malls will be back to their crowded days, which will result in steadier rental income and thus, attractive dividend yields for investors. We should also expect that once the community has reached herd immunity with the vaccines, we will eventually be back to normalcy — however nuanced that word may be — and people will start returning to their offices. The pick-up in demand for office spaces will also benefit REITs.
Investors looking for steady dividend yields may consider allocating a portion of their portfolio to REITs. The next few years will probably be difficult for investors looking for income when US Treasury bond yields are close to record lows and investment-grade bonds are at record lows. REITs may not have the security of a bond, yet they do bring pretty respectable yields. Investors are getting paid decent dividends while waiting for real estate prices to return to their highs. Something to consider, perhaps.
Ultimately, a well-diversified portfolio with both cyclical sectors and technology exposure is great as we believe a recovery is underway with the rollout of vaccines. Yield-based assets such as higher-yielding bonds are appropriate with central banks remaining very accommodative in their policies. Income from REITs can also supplement a portfolio’s returns.
In a reflationary market, it is a basic hygiene factor to ignore market hype and stick to assets that have strong and convincing fundamentals. As we look forward to normalcy soon, let’s help it along by keeping our physical distance and staying safe!
Michael Lai is vice-president of wealth management research at OCBC Bank (Malaysia) Bhd