Some of the world’s biggest money managers are betting on a swift comeback for battered reflation trades.
JPMorgan Asset Management, BlackRock and Morgan Stanley Wealth Management — which together account for some $12 trillion in assets —- say the bond-market gains that have sent yields into a sudden tailspin are nothing to worry about. It’s a temporary blip, they say, that belies a more comforting reality: that the global recovery is still on track.
“The rally in the bond market has gone too far, and it doesn’t reflect the fundamental strength of the economic outlook,” says Mike Bell, a London-based global market strategist at JPMorgan Chase’s asset-management arm, which controls $2.3 trillion. “Growth is going to be very strong and we don’t think the market has priced in enough rate hikes in the future.”
The reasons for such optimism are manifold. There’s plenty of evidence that the economic recovery is broadening, as the rebound spurs record job openings. To be sure, the growth and liquidity that support risk assets may be closer to the cycle’s peak than they were a few months ago, but that still leaves them ample room to run.
The message stands in contrast to the recent angst sweeping the world’s biggest stock and bond markets. U.S. stocks fell as much as 1.6% before cutting the drop by almost half over Thursday’s cash session. Pockets of data signaling a slower-than-forecast rebound from the ravages of COVID-19 have shattered trading strategies, such as yield-curve steepening bets favored by hedge funds and value stocks.
Seen through the prism of the U.S. Treasury market, the evidence of the market’s about-face is stark. Ten-year yields dropped below 1.25% Thursday for the first time since February, while real yields — which strip out inflation expectations — have tumbled deeper into negative territory, a classic indicator of a stalling recovery. Ten-year inflation breakeven rates — market projections for price expectations over the next decade — slid to their lowest levels since March.
Goldman Sachs isn’t convinced, saying lower yields, if anything, will continue to support risk assets. It’s staying “underweight” on bonds and “overweight” stocks on both three-month and 12-month horizons.
“I haven’t given up on reflation at all,” says Christian Mueller-Glissmann, the bank’s London-based managing director of portfolio strategy and asset allocation. “Just because you have peak growth and peak liquidity doesn’t mean that you have to go back to secular stagnation immediately. The market could still have multiple quarters, or even a year, where growth is still above trend.”
Risk-on
Even though Goldman strategists are bullish on stocks, they warn returns could drift lower from here. They’ve also become more selective with value stocks and added to less-cyclically sensitive sectors such as healthcare and staples, Mueller-Glissmann says.
JPMorgan’s core prediction is that above-trend growth will continue well into 2022, driving stocks — and eventually yields — higher. The manager ascribes the recent drop in yields to a range of factors, from concern over new coronavirus variants to a short squeeze in bond positions and buying linked to liability-matching by pension funds.
BlackRock, the world biggest asset manager with $9 trillion under management, is also staying in risk-on mode. It remains underweight on developed-market government bonds and prefers stocks to credit. The company expects higher inflation in the medium term, with a more muted response from the Federal Reserve and other central banks than in the past, according to its mid-year outlook.
The bond market has long been seen as a weather vane of economic growth. When yields fall, it suggests investors are either seeking safety or don’t see enough inflation risk to demand higher compensation for holding the securities.
“As it is, deep negative real rates are not discounting growth at all. In fact, they are predicting stagnation, or worse,” says Padhraic Garvey, head of global debt and rates strategy at ING Financial Markets. “We remain upbeat, but we also can’t ignore deep negative real yields. We target for them to become less negative as the recovery matures. But if they don’t, we’d be concerned.”
For Morgan Stanley Wealth Management’s Lisa Shalett, it’s wrong to believe growth will disappoint, that there will be a radical change of heart at the Fed, and that the world is heading into stagnation. Treasury yields are on the way back up, she says.
The company “remains optimistic that growth and inflation continue to surprise to the upside and that the yield curve will steepen,” Shalett, the New York-based chief investment officer, wrote in a note this week. “Watch for the 10-year Treasury yield to return to 1.75% during the quarter.”
