Equity Strategy - Time is coming to position for the long duration trade

Speaker: Mislav Matejka, CFA, Head of Global Equity Strategy

In terms of a move in bond yields, we believe that we are currently in a transition phase, rising bond yields at these levels are problematic for investor sentiment and for the economy, and are therefore ultimately not sustainable. Bonds RSI is becoming oversold and at some point soon this should morph into pricing in of a policy mistake, where bond yields are likely to start to move lower. Brent rally does mechanically imply that PPIs, as well as CPIs, could inflect higher again. That said, unlike the 2021-2022 episode, where bond yields and oil were moving up together for some time in order to reflect the economies reopening, and where the consumer at the time was accepting of rising prices, given pent-up demand and a strong post-COVID liquidity position, the recent oil rally was mostly for supply reasons. This could lead to demand destruction, and be deflationary, rather than inflationary. Looking at the past eight Fed tightening cycles, post the final hike, bond yields were down each time, by 100bp on average, irrespective of whether recession or soft landing followed. If bond yields roll over, will it help equity valuations? Not if yields are peaking at a time when earnings, and the broader economy, start to disappoint. In terms of sector leadership, we note that post the last Fed hike, the sector tilts would turn broadly Defensive, on a 6- to 12-month horizon, both in the US and in Europe, with Insurance, Staples and Utilities ahead. Another implication, apart from the likely Defensives rebound, would be to go UW Banks. Banks are well capitalized, show strong earnings trends, and have been the best performer in Europe over the last 6 months, given the higher for longer narrative, but could start to lag if/when bond yields peak out, especially if their NII income rolls, along with the potential credit backdrop worsening.

This podcast was recorded on 08 October 2023.

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