If you build it, do they come?

Market report

Government bond yields stabilised for most of this week, coinciding with a strong week for stocks and credit. Although long since incorporated into investors’ expectations, the major story of the week was the passage of the latest batch of US stimulus.

CIO

With the arrival of another giant slab of US government support, eyes now turn to the next effort – infrastructure. Expectations should be likely kept in check by recent history here. The tangible impact of both the Obama administration’s ‘shovel ready’ projects and the Trump administration’s ‘trillion dollar plan’ have been “vexingly scarce”[i] on US infrastructure, much of which dates back to the 1950s. Though there is broad agreement across the political aisle on the need for infrastructure spending, priorities vary widely as do thoughts on how to fund it. There is also justifiable scepticism as to the durable economic benefits[ii] – long-term mega projects that seem entirely sensible at inception can be rapidly transformed into white elephants by technological change, migration or the lack of it, and the various other un-knowables of the road ahead.

How this story evolves will be enormously influential for the outlook for capital markets too of course. If the legislative branch can find a way forward here, we might expect bond yields to continue to rise. Some will argue this should fuel a continuation of this year’s explosive rotation into some of the less fashionable parts of the stock market of the last decade.

There is certainly intuition behind the idea that there is a relationship between the shape of a company’s future cash flows, or duration, and the respective share price’s sensitivity to interest rates. The incredible dominance of mega cap growth stocks over the last decade has certainly coincided with ever lower real interest rates. However, our reliance on that intuition should be tempered by patchier real world evidence for such a persistent relationship. As it goes, this is why we continue to diversify across styles and sizes rather than bet the house on one or other.

The interaction between growth, inflation, interest rates and stock market valuations, both relative and absolute, tends to be significantly more complex than many will tell you. To this end, if you plot various real and nominal interest rate regimes of the past against corresponding stock market valuations, you can see clearly that the relationship is not linear. The reality is that stock market valuation multiples and interest rates are shorthand for myriad, mostly overlapping, factors where cause and effect can be hard to accurately disentangle.

For the moment, the anatomy of this latest bond market sell-off seems to suggest a positive reappraisal of the world’s growth prospects – the same factors driving yields higher, will likely also be burnishing corporate revenue growth prospects.

[i] https://www.brookings.edu/blog/the-avenue/2021/02/17/how-biden-can-succeed-on-infrastructure-where-trump-did-not/

?[ii] https://www.city-journal.org/html/if-you-build-it-14606.html

Learn about Barclays Wealth Management, the affluent and high net worth service provider for Barclays UK.

or

Find out about our 'Ready-made investments' via our Smart Investor platform. A selection of five Barclays funds that each aims to increase the value of your investments over time, using a broad mix of asset classes from across the globe.

*This article is for information purposes only. It is not intended as a product offer or investment advice.