For the thirty-second week in a row capital flowed out from the European equity markets...and the trend seems to have gathered pace this week, with outflow of USD 2.5bn from European equities compared to 1.2 billion last week. The big winners in terms of inflow so far in 2016 are emerging debt, real-estate and investment grade bonds. As an illustration, Saint-Gobain recently managed to raise one billion euros through the issue of a BBB rated bond, with maturity of 3 years and yielding close to 0%, which was oversubscribed 2.6 times. However, this period may be finally drawing to a close. Long-term interest rates around the globe are edging higher, from Japan to the US and also in Europe. As such, Japanese 30-year yields steepened from 0.05% in July to 0.55% today, which could almost be qualified as a bond-market mini crash. 10-year Bund yields are positive once again, while US 10-year rates are at almost 1.7%. Central bank intervention will now be considered less efficient or less necessary by investors. The next Fed meeting should confirm the date for the next rate hike. Equity markets, which do not generally appreciate this type of turnaround phase in the fixed-income markets, gave back some ground this week. However, a progressive steepening of interest rates will benefit a number of sectors, including banks, insurance, companies with heavy US or UK pension fund allocations, and groups with comfortable net cash positions which are currently earning zero. It will also be bullish for the cheapest so-called value stocks, compared to their overvalued “super growth” counterparts.
Furthermore, companies which generate recurrent operational cashflow and enjoy solid balance sheets will also be in a good position to face the rate-hike cycle. It is not yet clear how the interest rate scenario will pan-out, as the artificial coma induced by the low rate environment has lasted for a long time and will certainly have repercussions among investors. Inflation outlook remains bearish and growth forecasts have been weighed down by political demons (Brexit, recidivist elections). However, if investors were able to correctly price their debt once again, they would suddenly notice that they have financed a transfer of historic value between creditors and shareholders.
Igor de Maack, Fund manager and spokesperson at DNCA. This article was finalised in September 16th, 2016.
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