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Market Insight, 16/04/2021

April 16, 2021 – Written by James Baxter

There are a few investment market indicators we have in our sights to keep an eye on the big picture.

Treasury rates and inflation

US and UK gilt yields have stalled in April having reached lows of just over 0.5% last Summer. The US 10-year rate has settled at around 1.6%, just below the rate it was at the end of 2019 and well below the 3% it hit in late 2018 when its rise cooled equity markets. We need to keep an eye on inflation but we do not think there is currently cause for concern. Last recorded in March in the UK it was just 0.4%, forecasts for the next 12 months are 1.5%; still below the 2% target set by central banks.

Corporate bond yields

The yields on our short-dated bond funds, our lowest risk funds, are just under 3% and covering historic inflation plus costs. Our higher yield, longer dated funds are generating yields of around 4%, giving us inflation plus 1%, remembering the managers will generally add to these returns through active management.  The short-dated funds are a good buffer against future withdrawal needs and lower the risk of portfolios.  The longer dated higher yield funds should provide a pretty reliable return on a medium-term basis and in doing so help us meet our target returns with more consistency than if we just relied on equities.

Equity valuations

The FTSE 100 passed 7,000 this morning. It is the fourth time we have been here, with the index first hitting this level at the end of 1999 twenty-one years ago. It did not hold that value for long, set back by the post millennium dot com crash.  It regained it again in the Summer of 2007 only to be knocked off course by the Great Financial Crisis of 2008.  It recovered it again by 2017 and stayed at or above that level till the end of 2019. I remember thinking in the Autumn that year it might finally push on and break free, 8,000 here we come. We all know what happened next.  At the same time it is interesting to note that the more domestically focused FTSE 250 continues to achieve record highs, having risen by c.26% in the last six-month period.

US equities are pushing new highs but by contrast the S&P 500 is up almost threefold since the end of 1999.  So, are US equities ridiculously expensive and UK equities ridiculously cheap?

On a forward basis, the S&P 500 earnings yield is c.4.5%, three times the US ten-year risk- free rate. The FTSE 100 companies, on a similar basis yield almost 7%.  That these rates are not miles apart by now, after the relative movements of the two indices over the last 20 years, tells us that US companies have lived up to their historically higher valuations and have grown their earnings far more quickly than the FTSE 100 companies. 

As we have discussed in this column before, the S&P 500 can be seen as a proxy for ‘growth’ companies; technology, health care and internet-based businesses, whilst the FTSE 100 is more of a proxy for ‘value’ or ‘cyclical’ style companies with earnings growth more routed to economic growth cycle; banks, insurance companies and energy companies. That the shares in these companies are gaining momentum reflects economic growth expectations and their relatively low values compared to other companies.

Today, China, the second largest economy on the planet, and almost five times the size of the UK economy, announced the biggest annual growth in economic activity since its records began at 18%.  Whilst global economic growth may be muted, it is clearly not over and China is leading the way out of the pandemic.

It would be a brave person who bets against the US markets for the next 20 years, but in the short term our value funds have had a nice boost and we see more to come as economic activity picks up.

Investment Update, 16/04/2021

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