The bull-run in stocks has at least another six months to go, who recommended increasing equity exposure to levels not seen in over a year, despite a frenzied sell-off in financial markets in February.
A rout in bond markets sent yields flying with the return on the 10-year Treasury note rising to a one-year high this month, driving distressed selling in global equities and leading to heavy losses from all-time highs.
But the Feb. 10-25 poll of fund managers and chief investment officers in the United States, Europe and Japan – with a total of more than $4 trillion assets under management – showed equity allocations accounted for 49.5% of the model global portfolio, the highest in over a year.
Global funds also recommended cutting bond holdings to 39.8% from 40.1% in the previous month, the first time in two years the suggested average fixed-income allocation has accounted for less than 40% of the model portfolio.
“The explanations to the run-up in global stocks to record highs since the pandemic have been tenuous and so are the reasons for the whiplash in bonds and the carnage in equity markets in February,” said a chief investment officer at a large U.S. fund management company.
“Looking beyond the short-term noise, we acknowledge the reflation trade for what it is: better economic growth prospects amid dovish and jobs-first rhetoric from central banks – which is widely positive for stock markets, despite the recent surge in yields on inflation worries.”
Government bonds have become the focal point of markets, after trading showed positioning for higher inflation internationally, even after U.S. Federal Reserve and European Central Bank officials tried to talk down rising yields.
While higher bond yields could make stocks appear relatively less attractive on lofty valuations and a diminishing dividend advantage, the latest poll marks the fourth consecutive month of recommendations in favour of equities.
“The recent choppiness of equity markets while yields drift up adds to investors’ nervousness. But, we believe drivers of the yield move are crucial,” said Justin Onuekwusi, fund Manager at Legal & General Investment Management.
“As long as rising yields are driven by a combination of higher inflation and better growth prospects, it is positive for markets. There is little long-run return potential in bonds which makes long-term expected equity returns, albeit lower than normal, still quite attractive.” More than three-quarters, or 19 of 25 asset managers in response to an additional question said the broad run-up in global stocks would continue for at least another six months, including nine respondents who said longer than a year.
That echoes findings in a separate Reuters poll of around 300 equity strategists who expect the broad trend of stock market gains to continue this year.
“Without doubt, monetary and fiscal support has been a major driver (of stocks). In the near-term, there is little evidence of this support to fade – actually the opposite seems to apply, especially in the United States,” noted the investment team at Generali Investments Partners.
But more than 70%, or 18 of 25 fund managers in response to another question said corporate earnings would take longer than six months to return to pre-COVID-19 levels, including 12 who said longer than a year.
With earnings still some way below pre-virus levels, hefty stock valuations make equities sensitive to rising bond yields – taking away some of their allure, especially high-flying tech stocks.
“While historically a pickup in inflation has been positively correlated with the performance of equity markets as a whole, below the surface things could be more nuanced,” said Kevin Thozet, member of the investment committee at Carmignac.
“Such an environment would likely benefit reflationary equities. But it could be different for the other part of the market and notably those where valuations are very high.”
Underscoring the caution over lofty equity valuations, all-but-one of 25 respondents answering another question said a significant correction – commonly defined as a fall of 10% or more – in stock markets in the next six months was likely.