Global selloff in government bonds has rippled through to the stock markets as investors are increasingly scrutinizing earnings as a driver of growth
Interim correction in stocks may provide a buying opportunity, as long as profit potential far outweighs the sharp rise in government bond yields
Just when you thought it was safe to wade into the markets again, the global sell-off in “safe” government bonds kicked up a notch yesterday when the benchmark 10-year U.S. Treasury yield soared above 1.4% for the first time this year (yields rise when bond prices fall).
European governments were also caught in the crossfire with yields on British, French, German and Italian bonds surging.
The broad selloff in government bonds is the product of several factors, including a more upbeat global economic outlook and rising concerns over inflation, as well as fresh fiscal stimulus out of the U.S.
Investors are increasingly betting that effective coronavirus vaccines will boost economic growth and fan the flames of serious inflationary pressures for the first time in decades.
And that selloff in fixed income has started to ripple through global stocks.
During the pandemic, the near-zero yields on “safe” government bonds meant that investors shifted into equities and corporate debt, because they were seen as better alternatives to the lack luster returns from owning sovereign debt.
But with rising government bond yields, and higher commodity prices, investors are understandably concerned this may trigger a correction in equities.
If history is any guide, as happened in both 2003 and 2009, in the early stages of an upturn, higher rates can be offset by rebounding profits.
A Société Générale report points to consensus forecasts of a 30% rise in earnings this year from companies in the MSCI World Index and 40% for emerging markets.
And even if stocks were to correct from their somewhat expensive levels, their potential for a stronger rally thereafter is significant – as stocks tend to rise and fall with the direction of profit and profit expectations.
Which is why the recent selloff in bonds spurring a knee-jerk reaction in the form of an equities correction is likely to be short-lived.