A new economic cycle has begun with most economies in the world showing robust data underscoring the vibrant recovery. The release of pent-up consumer and business demand is likely to be very strong, based on recent economic and corporate releases. The faster-than-expected vaccination has meaningfully reduced the odds of a prolonged economic weakness.
In the financial markets, the magnitude of the upcoming US fiscal policy is a critical factor behind the rise in bond yields. The market is testing the FED’s resolve in continuing with its easy monetary policy stance when the US 10-year Treasury yields started rising. In our view, monetary tightening would be premature, as it will take time to develop persistent inflationary pressure and a return to full employment. We should bear in mind that the healing in the jobs market is a prerequisite for the FED to declare that its dual-mandate has been accomplished before they commence monetary tightening.
To us, the rising bond yields is orderly and the FED would make sure of that in the foreseeable future. This is because monetary policy is not an appropriate tool to address perceived excesses in the financial market and potential instability.
The FED will allow some re-pricing of interest rates at the long end of the curve, suggesting that sustained inflation should happen in the long term and tighter policy further down the road. To refresh, the 10-year bond yields were trading at close to 2.0% before the global pandemic in December 2019. Therefore, it is not unusual for market interest rates to rise to current levels.
From a historical perspective, the stock markets were generally under pressure in the early stages of a US rate hike cycle expectation. However, US rate hike cycles as well as treasury yield increase generally indicate a stronger economic growth outlook in the US. We are currently at the point of moving into the phase of improving economic and corporate fundamentals from plentiful liquidity earlier. Investors will now need to pay more attention to earnings and valuation of stocks in making investment decisions going forward. Hence, a stock selection market which plays to our strengths of fundamental-driven investing.
While some stocks may look somewhat expensive, we do not believe global stocks as a whole are close to a big bubble territory. The US cyclical adjusted PE valuation is currently trading at 35.2x, still lower than the reading of about 45x back in 2000. The high valuation is concentrated mainly in the Technology stocks, but the rest of the markets is still nowhere near excessive levels. If we were to look at the rest of the world, especially in Asia where we are weighted heavily in the portfolio, they are still at relatively attractive levels for investors to buy. It is therefore not surprising to hear that Chinese state funds have stepped in to buy stocks when there is weakness in the market.
We will from time-to-time add new names when opportunity arises to further improve the portfolio mix. The current environment is one such moment where we can take advantage of stock price weakness due to indiscriminate selling in the market. We are constantly aligning our forward-looking views on the markets and stocks for any systemic changes in the global arena ranging from economic to geopolitical issues.