Key takeways

  • A persistent trend upwards in equities.
  • Government bonds have not yet priced in economic activity.
  • The big rotation continues, and volatility should remain high.
Investors continue to fuel the reflation trade, ignoring the first signs of exuberance. Economic figures stay resilient and vaccination campaigns are supposed to end the pandemic this summer at the latest. Fiscal stimulus will boost optimism about a strong recovery during the second half of 2021. Earnings should rebound sharply, which should remedy market valuation concerns. Even if the latest move on treasury bonds has slightly reduced the pressure on their valuation, most of our tactical indicators indicate a coming increase for the long end of the yield curve.

The trend is your friend
Little can stop the current trend in the short term. The good earnings season in the US confirms the strong earnings forecasts. The fundamental momentum on equity markets has slightly weakened in February but is supposed to stay positive (see Chart 1). The Eurozone continues to lead the movement.

Chart 1: Evolution of equity market fundamentals over 2 months

Microeconomic factors are still the most positive drivers for equities. Macro factors are weak due to the strength of US data. This is because strong and fast pace in economic activity normally leads to less accommodative monetary policy. With the exceptional nature of a pandemic and the new FED strategy, it is unclear that Central Banks would act at the first signs of reflation. Finally, we don’t see market valuation as a concern yet.

On a tactical basis, a 20% return in 3 months leaves limited upside potential. But there are no serious reasons to be cautious. Investors positioning is elevated but not extreme, and many investors hedge part of their risks, which should limit the impact of any reversal for the moment.

More value in Government Bonds but far from fundamentals
The last figures in Government Bonds fundamentals are interesting. Sovereign yield valuation seems less depressed than anticipated. Our models highlight a strong move in fundamentals, due to less expensive valuation levels after the recent spike in long term maturities. We also witnessed a significant change in drivers such as economic momentum and risk aversion.

Chart 2: Evolution of core sovereign bond fundamentals over 2 months (09/2020 - 12/2020)

Tactically speaking, we consider that several technical factors indicate a more cautious stance on sovereign bonds. Fundamentally speaking, we believe long term yields do not fully integrate the strong recovery of the economic activity (see Chart 3).

Chart 3: Equity market trend analysis (1996 - 2020)

What’s Next?
Despite remaining uncertainty, the Big Rotation continues. Resilient economic momentum, vaccination campaigns and strong fiscal stimulus drive risk aversion down. We should see continued steepening in the US yield curve and spread to other treasury markets. We expect a consolidation, but it is difficult to say when and where. Nevertheless, cyclical market and asset classes should stay in favor in the medium term. Equity volatility should remain elevated and hedging strategies can help in this challenging environment.
Written in February 2021.

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