Fidelity International’s Tom Stevenson (pictured) shares his weekly market insights, examining the implications of persistently high bond yields, the resilience of US equities amid political uncertainty, and the long-awaited emergence of global markets and value stocks as viable alternatives.
Sharing his latest thinking into what’s driving markets this week, Tom Stevenson, Investment Director, Fidelity International said: “After weeks of volatility, shares settled at the top of their recent wide range last week as investors have increasingly viewed recent tariff threats from the US administration as less impactful than initially feared.
“There’s a growing perception that, when faced with market pressure, the US President may ease back on more bold measures to maintain economic and market stability. This pattern – of bold announcements followed by partial or full reversals – has repeated several times in recent months, helping calm investor nerves.
“We’ve seen this before: the ‘liberation day’ tariffs were quickly paused in April, and tariffs on China were also reversed. A more recent fiscal plan suggested policy tightening is off the table for now – further reassuring markets.
“In the short term it’s a positive for the market and, having dipped briefly below 5,000, the S&P 500 index is back within spitting distance of 6,000 again. This reinforces the view that markets could remain strong even if it means more inflation and a possible interest-rate-fuelled correction later down the track.
A cautiously bullish outlook
“So maybe the ‘buy the dip’ optimists have been right all along. It is obviously a trade that has worked well in recent weeks, just as it has pretty much ever since the financial crisis 17 years ago. One possibility is that despite everyone’s worst fears for recession, for renewed inflation, and for a damaging trade war, the bull market still has legs.
“Reasons to think that might be the case, include the pattern of recoveries from previous 20% declines in the past. When markets bounce back as quickly as they have this time, it has often been because the fall was no more than a bearish shock in an ongoing bull market.
“Other bullish pointers include earnings growth, which remains positive if a bit more subdued than it has been for a couple of years. Sentiment is still a tailwind because it remains cautious – the time to worry is when everyone is bullish which they are clearly not right now. And, finally, liquidity is a positive. Fiscal expansion is driving strong growth in the amount of money sloshing around the global economy and that tends to be a positive for equity markets.
The bond yield ceiling
“The bond market, however, presents a counterpoint. Lots of liquidity might be cat nip to equity investors in the short term, but it’s never welcomed by the bond market. More liquidity means rising deficits which have to be funded by governments issuing more bonds.
“At the best of times that will tend to drive bond yields higher, but it is even more of a problem now that central banks are no longer mopping up the excess supply of Treasury bonds. With the buyer of last resort out of the picture, more supply and less demand is pushing bond yields back to 5% and beyond. And all other things being equal that makes shares less relatively attractive to investors. They can get a similar return for less risk in bonds than shares. And that means that shares have to fall in value to boost their yield and become more competitive.
“Looking back at the period from the 1950s until the 1990s, when this relationship last held before zero interest rates and quantitative easing muddied the waters, a 5% 10-year Treasury yield tended to equate to a price/earnings ratio for shares of around 17 or 18. That’s well below the current level in the low 20s and suggests it would take a 15-20% fall for shares to become obviously attractive again.
“This explains why shares have traded in the 5000-6000 range since the start of the Trump 2.0 period. And we are now at the top of that range.
Investors look beyond the US
“While the US has led markets for over a decade – driven by tech dominance and capital inflows – the global picture is shifting. Investors are starting to question the US exceptionalism story. And that is helping markets in the rest of the world.
“It’s been a long wait, but the MSCI All Country ex-US market index has finally hit its first all-time high since 2007. The rest of the world has lagged the US throughout that period but no longer and investors are finding safe havens beyond America in markets from Europe, including the UK, to Japan and even China.
Will value have its moment?
“One other aspect of this diversification trade is that finally, after countless false dawns, it is possible that value shares – lowly rated, unpopular stocks offering short term income but little in the way of long-term growth – may start to be repriced relative to the high-flying growth shares that have led the way for so many years.
“The strong performance of value funds are pointing to this rotation, although it’s worth pointing out that investors have been calling for this rotation for many years, only to be disappointed.
The week ahead
“Looking ahead to the current week, the highlight will be the latest meeting of the European Central Bank at which anything other than another quarter point rate cut will be a big surprise. Markets are pricing in a 97.5% chance of that move, which would take the cost of borrowing in the euro area to just 2%. It will be the lowest level for more than two years and half the level of last June when the ECB started to cut.
“Before Thursday’s meeting we will have seen preliminary inflation data for May on Tuesday which is expected to show prices rises back at the ECB’s 2% target.
“At the end of the week, attention will shift back to the US when the next batch of non-farm payroll data will be released on Friday. Economists expect 130,000 new jobs to have been created in May, down from 177,000 in April and 272,000 a year ago. A weakening in the labour market has been expected given fears of a possible recession, but one of the key surprises in the US economy in recent years has been the ongoing strength in the jobs numbers.”
