Rising US Yields Bolstering Asset Class Strategy
The global economy picked up momentum in July, providing initial confirmation to our view that growth had troughed and would improve in the second half of 2013. Most notably, manufacturing purchasing managers' indices, from China to the US, were in expansionary territory (above 50.0) in July, with the US hitting a particularly impressive 55.4. Even the eurozone published a reading above 50.0 for the first time in two years.
Against this backdrop it is little surprise that bond markets are selling off, with the US 10-Year Treasury yield above 2.7% and looking like it could potentially explode higher. Though we do not believe it provides the most appropriate fundamental comparison, the side-by-side chart of 10-year UST yields in the 1994 and 2013 bond sell-offs shows eerie similarities, and suggests further fixed income downside. As US equity markets hit new highs, we still see little value in fixed income, and think 10-year Treasuries could end the year at 2.75-3.00%.
This will have implications across global markets , as rising safe-haven yields will increase the opportunity cost of investing in a variety of asset classes. Consumer discretionary stocks, for example, look like they may break higher against staples stocks. As the chart below shows, the discretionary to staples ratio (based on the MSCI World indices) tracks the UST yield fairly closely . This is sensible, given that higher yields indicate a reflationary, risk-on environment, in which discretionary shares should outperform. A break higher would also provide confirmation that growth, in developed markets at least (this chart represents the MSCI World), is on an increasingly sustainable footing.
|Growth Rebound Underway|
|Manufacturing Purchasing Managers' Indices|