Stocks have rallied strongly off their oversold October lows on soft landing hopes, with the move extending after a benign US inflation print.
Leadership has been narrowly focused around the big technology names, as you’d expect with 10-year Treasury yields dropping from close to 5.0% to below 4.5% in the space of a month.
Growth stocks, like technology, tend to outperform when bond yields fall (see chart). This is because the bulk of their future expected dividends are weighted far into the future and a small drop in the discount rate can result in a large increase in present value.
Upper panel: MSCI global growth vs value stocks and US bond yields (inverted). Lower panel: Technology vs the world
Source: LSEG Datastream as at 13/11/2023. Royal London Asset Management.
We would expect growth stocks to continue leading the market higher if US inflation eases enough for the Federal Reserve to signal that rates have peaked. In this scenario it would be quite plausible for US and global business confidence to stage a gradual recovery, supporting a sustained rally in stocks over the seasonally strong October to May period.
On the other hand, if inflation remains stubbornly high or if tight monetary policy continues to weigh on the economy, then stocks, including technology, could suffer a relapse. In a hard landing scenario, with the US and other economies moving into recession, we could even see the usual relationship between growth stocks and bond yields break down. This is what happened in 2000-2003 when massive earnings downgrades saw tech stocks crash despite large falls in government bond yields.
The long lags of monetary policy in this cycle, with so many borrowers still on low fixed rates, raise the possibility of both scenarios being true: with the long-expected recession once more delayed, not cancelled.
In active management, the journey can be as important as the destination.
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