Bond yields have bounced. Ten-year Bund yields have risen around 20 basis points from their early September record lows to currently trade at -54 basis points, and US 10-year Treasury yields have gained around 25 basis points to reach 1.72%. Over the same period there have been some notable shifts between different investment styles within equity markets.
Quality, minimum volatility, growth and momentum stocks have underperformed the broader market since 6 September. For example, quality stocks (which include cyclicals such as tech and some consumer staples) have underperformed the index by -1.5% in the Eurozone and -0.8% in the US. Minimum volatility stocks have underperformed by -0.8% and -1.6% respectively.
We view these moves as strongly related to the jump in bond yields. Both styles are heavily underweight financials and energy & materials, which usually perform well when bond yields rise. But we do not expect significant further upside in yields:
- In the next two weeks we expect both the European Central Bank and the Federal Reserve to deliver further monetary policy easing. While we see scope for market disappointment in the extent of easing, particularly by the ECB, the rise in yields has partly priced this in.
- Growth is slowing, and trade uncertainty remains high. We forecast global growth to slow from 3.2% this year to 3% next, which would be the slowest pace since 2009. In the US we expect growth to decline from 2.3% this year to 1.3% next, and the respective figures for the Eurozone are 1.1% and 0.7%. As a result, we anticipate bond yields will remain under pressure over the near term. Our year-end forecasts are for 10-year Bund yields of -0.6% and Treasuries of 1.5%.
- Our base case is for the US and the Eurozone to avoid slipping into a recession in 2020. Over the medium term, we see 10-year yields remaining relatively stable. Our current forecasts over 12 months are 1.7% for Treasuries and -0.4% for Bunds. We see risks tilted to the downside – further trade escalation, for example, would likely prompt more aggressive central bank easing and likely push 10-year yields lower.
With economic data showing broad-based signs of moderation and risks of recession elevated, we favor exposure to more defensive equity styles. Among defensive styles we have a global preference for quality stocks and for quality and minimum volatility in the Eurozone. Year-to-date quality stocks have outperformed the broader market by 3.3% in the Eurozone and 4.3% in the US. While the recent sharp move in yields has led to temporary underperformance of these styles, we do not expect this to persist.
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