Investors are worrying about the wrong thing when it comes to recent market movements, Sacha Chorley, portfolio manager at Quilter Investors, said today.
Bond yields have risen sharply and growth equities have sold off as investors appeared to become concerned about a looming uptick in inflation as lockdowns ease and economies normalise.
This has seen some abrupt market movements, however, Chorley believes this fear of inflation has been misplaced and has not been the one driving markets in recent weeks.
"The commentary suggests investors are worrying about a return to an inflationary environment as a result of the overwhelming monetary and fiscal support that has been required to prop up the global economy," he said. "Coupled with lockdowns easing and mass vaccinations, there are concerns we will see inflation return. But market movements have not been driven by inflation prospects, rather the rise in real yields we have seen across the board.
"If you look at market based expectations for inflation, it is true that indications are above the 2% target many central banks set. But crucially it has been a steady increase since 2020 rather than a sharp rise, and the latest drop in markets actually coincided with a decrease in these inflation expectations.
"Indeed, the Federal Reserve has not changed its guidance on inflation, so these fears do appear slightly misplaced just now."
Chorley is unconvinced we will see a sharp rise in inflation when demand does return.
"Inflation does have the potential to rise but there are structural issues at play here that have been created by the pandemic. Unemployment has begun to creep up and once support schemes are withdrawn it is likely to keep climbing. Part-time employees are out of work just now, so there are multiple cohorts that will not be in a position to spend as the economy opens up.
"Furthermore, a lot of emphasis is being put on the mass of savings that has been accumulated during lockdowns. But there is no guarantee this cash pile will be spent, especially given the accumulation has largely occurred in wealthier households. With uncertainty abound many will sit on these cash buffers in case the worst happens to their situation.
"Central Banks will also ensure inflation does not get out of control and have plenty of room in their policy arsenal to crush any spikes."
With real yields rising, Chorley believes now is the time for investors to be thinking about adding to their exposure to value companies. He also sees this as an attractive entry point for traditional fixed income given the rise in bond yields.
"Value is likely to be the big winner from an uptick in bond yields. We expect it to be a broad rally for now, before sectors like financials benefit over others. Value has been in the doldrums for some time, but things are looking up for it with increased growth expectations and this rising yield environment, and as such now may be the time to begin adding a more substantial weighting to portfolios.
"Furthermore, given bond yields and the shape of yield curves, this looks like the best time to add into government bonds since 2015. Starting to add some fixed income exposure might be quite prudent in order to add some ballast to portfolios."
