Slowing economic growth represents a larger risk to the prospects for equities than rising inflation, according to a recent BofA Securities’ Global Research report.
While a recent surge in commodity prices and the jump in US core CPI inflation to a 25 year high have triggered concerns about inflation risks; Sebastian Raedler, investment strategist at BofA Securities, argued the pro-risk, pro-cyclical environment will likely only end once the macro cycle peaks.
“Rising inflation impacts equities by leading to more hawkish pricing for central bank policy and, hence, rising bond yields – ie the discount rate for equities,” said Raedler.
“However, the sensitivity of equity moves is notably higher to swings in growth momentum than to those in the discount rate.”
Market taper tantrum
For Raedler, this suggests higher inflation and rising bond yields will only present a problem for equities for two reasons.
First, if they coincide with a peak in the macro cycle in a manner that equities lose the protective impact of improving growth momentum, and second, if they result in a bond market taper tantrum in which bond yields rise 100 basis points over a short period of time.
Raedler said that such a tantrum would overwhelm the support for improving growth, as happened in 2013 and 2015, which would lead equities to drop by 10% in response to the spike in real rates.
Despite this, Raedler said BofA Securities remains positioned for one last leg of growth acceleration and a further rise in bond yields.
“We expect further upside for the US 10-year bond yield to above 2% on the back of improving growth momentum and rising inflation – in line with our rates strategists’ year-end target of 2.15%,” he said.
“Our macro assumptions imply a further 5% upside for the Stoxx 600, as well as 10%+ further outperformance for cyclicals versus defensives, value versus growth and financials, all of which benefit from both accelerating growth and rising bond yields.”
