Banks and resources the winners if fiscal policy takes the batton
Duration is a term used to describe a bond’s price sensitivity to changes in interest rates; the longer the duration, the greater the sensitivity to a change in rates. Therefore, as long-term rates have materially decreased over the past few years, and even going negative in many instances, the returns from long-term bonds have been very high.
This is even more notable for the overcrowded long duration, low volatility sections of global equity markets such as Staples, Utilities, Infrastructure, and Telecommunications. Unsurprisingly correlations to the ten-year bond of these sectors are close to decade highs. The same trade has been put on across different sectors and indeed perhaps more worryingly across multiple asset classes. Consumer staples are trading at 90 year highs relative to the S&P 500 while US Banks are trading at 75 year lows. There is a great deal of confidence in the reliability of cash flows very far out in the future. Put another way, the discount rate on these future cash flows is low to non-existent, whether it be fixed income or equities.
As things currently stand, the overlap between momentum, duration and quality is sufficiently large to relegate them as one and the same. It is thus fair to say the quality is exceptionally priced, and prone to significant corrections. The best quality equities are no less overpriced than the highest quality bonds.
The risk is that if there is any loss of confidence in the actions of central bank the resultant market reaction can be severe and sudden. It is inevitable that the momentum and crowding within long duration assets will reverse.
Chad is the Co-Chief Investment Officer and co-founder of Talaria Asset Management. He has more than 20 years’ experience in the financial services industry in the UK, South Africa and Australia. Talaria's investment strategy seeks to increase the...