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Five insights in five minutes

Five in Five: Fed hikes, China rate cuts, inflation, bund yields, VC
21 January 2022

    Fed hikes and equities

    We have written before that rising interest rates have no long-run effect on equity prices. The theory says so: a higher discount rate is counter-balanced by a stronger growth rate in cashflows (you can’t change one in your valuation model and not the other). There is no historical correlation either. Indeed, in the 1950s and 1960s buoyant stock markets were synonymous with rising rates. But what about the short-run? Investors get nervous because for the last two decades they have witnessed lower rates and strong returns. There are also occasional spasms whenever the Fed threatens to tighten. However, as you can see from the chart created by our strategy team below, US and global shares seem to take rate hikes in their stride. The lines show real cumulative returns (including dividends) in months following the start of the previous ten tightening cycles. Two years in, the S&P 500 and MSCI World indices were up 20 per cent, on average.

    Conversation starter for… global equities, US equities, risk assets

    Fed hikes and equities  

    China rate cuts

    Although China’s economy is hardly decoupling from America’s, its monetary policy is moving in the opposite direction. Markets expect four hikes from the Fed this year. Meanwhile, the PBOC has just cut each of its two major policy rates – the seven-day reverse repo rate and the one-year medium-term lending facility rate – by ten basis points. Since 2016, there have been nine cuts in either of these two policy instruments. Six times out of nine the Shanghai Shenzhen CSI 300 reacted with positive returns, the rest being negative. In fact, the median two-day performance post announcement comes out to around one per cent. Therefore, a rate cut might bring some immediate benefits, but hardly something to base your long-term investment decisions upon. The latter should be driven by valuation. China’s CSI 300 index now has a forward price-to-earnings ratio of 14 times versus 18 times a year ago. That’s a whole lot more net earnings for your renminbi.

    Conversation starter for… China equities, China bonds

    China rate cuts  

    Inflation beating assets

    Fun fact for the under 40s: today’s US consumer price inflation at seven per cent is the highest of your lifetime. Temporary though it may be, the chart below can help investors beat record inflation. Look to the assets on the right – namely Asian stocks and alternatives, which offer the most attractive prospective returns per our strategists’ valuation framework. Private equity accounts for the biggest share of alternative assets, and is forecast to grow to more than half by 2025, providing access to new investment themes via innovative start-ups. Naturally, real assets appeal during periods of inflation, and there is none larger than property. It currently accounts for two thirds of real assets, according to McKinsey, and offers rental incomes that tend to rise with higher prices. Lastly, Asian stocks now trade at a 20 per cent discount to global peers based on earnings, with a long-term investment case that remains intact as home to a projected two-thirds of the global middle class by 2030.

    Conversation starter for… alternatives, Asia equity

    Inflation beating assets  

    Positive bund yields

    Europe is celebrating two decades since the first set of crisp euro notes left ATMs and exchanged hands. But another European anniversary is being broken, with the ten-year German bond yield finally breaching its almost three-year tradition of being in negative territory. Yields rose to 0.02 per cent on Wednesday 19, pulled by the Fed, higher-than-forecast UK inflation, and therefore expectations of increasing rates in Europe too. Can bund yields stay in the black? For this to happen, the ECB would need to be hiking rates this year. However, it wants to see forecast inflation at target (two per cent) over the medium term first, and only has 1.8 per cent pencilled in for 2024. Besides, our strategists reckon that the central bank wants to focus on adjusting asset purchases in the next 12 months. That’s why investors shouldn’t read too much into positive bund yields.

    Conversation starter for… European fixed income and equities

    Positive bund yields  

    Venture capital

    As most central banks are anticipated to take action to cool inflation, US ten-year treasury yields are closer to two per cent and bund equivalents have just turned positive for the first time since 2019. Enough to quench your thirst for yield? Obviously not. Instead, investors seem readier than ever to venture outside their comfort zone for higher returns. As illustrated below, periods of low yields tend to be the most prolific in terms of venture capital deals. Historically, when US ten-year treasuries were yielding below 2.7 per cent, there were between 1,500 and 2,300 deals per quarter, according to Preqin data. As venture capital assets under management have tripled $1.7 trillion over the past half-decade or so, most of those deals are fairly recent. Given that rates remain relatively low and economies are strong, expect early stage companies with bright ideas to add a few more dots to the top left corner of this chart.

    Conversation starter for… venture capital, alternatives

    Venture capital  

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