China has now started to talk down some of its recent currency strength, including hiking their
reserve requirement ratio. Now this has only had a limited impact on the yuan, but it highlights
an issue that too much dollar weakness is also a problem for the global economy if it encourages
inflationary pressures, even though it's not as historically damaging as a stronger dollar can be.
China has seen its exports to the US surge during the last 12 months,
which has so far not been handicapped by currency strength. But there are ongoing concerns about
high commodity prices and rising US inflation that could cap demand for all products. Despite all the
concerns about inflation, global yields are not reflecting a fear about prices surging higher.
In this Big Conversation, we'll look at why those yields remain resilient
and how it would be a positive outcome for tech stocks again.
One of the main concerns over inflation in recent months has been its negative impact on the growth
stocks that had led the US equity market performance up until the middle of last year.
Growth stocks are those stocks which are able to grow earnings during periods of slow as well
as fast economic expansion and include many of the tech names and internet darlings. Since last year,
the ratio of growth versus value has stumbled, with growth stocks taking a significant leg lower
this year when commodity prices started to take off and bond yields were rising to their highs at
the end of March. When the ratio is viewed over the longer term, you can see why so many people
are worried. It looks like current price action could be a repeat of the dotcom period, where
growth names saw a period of both extremely rapid outperformance and equally severe underperformance
once the reversal took hold. Many of today's fears are on the expectation that inflation continues to
penetrate all walks of life and that bond yields will surge. Growth stocks have increasingly become
bond proxies, generating returns when yields and growth were low. As a result,
growth was outperforming when yields were falling, but during the recent period of high yields,
value names such as banks and heavy industry have been the winners. But if anything, bond prices
have been remarkably well behaved considering the current fears about inflation. As we've seen
before, many inflationary assets have experienced massive year on year increases. Obviously much of
this is the result of the base effects which will ease. Last year's price action has been
instrumental in the massive year on year gyrations in the WTI oil price after negative levels were
registered in April last year. But these are now starting to work their way through the system.
Given the current level of spot inflation, bond yields are at remarkably low levels, the last
time we saw a headline US Year on year CPI above 4%, the US 10-year was also around 4% rather than
the 1.7% level that it's reached this time around. It becomes even more striking when we look at the
US 10-year yield minus today's spot inflation. This is currently the lowest level of real yields
since the inflation shock of the late 1970s and early 1980s, though both inflation and yields
were far higher back then, which in many ways makes the current disparity even more extreme.
But this is not just a US problem, which may be one reason why there is still foreign demand
for US fixed income. German real yields have also now fallen deep into negative territory.
Obviously German nominal yields are starting off a much lower base than in the US.
The German 10-year bund yield is still in negative territory. But now that we've seen
a surge in European inflation data to over 2%, a level the ECB has been struggling to hit for
most of the last decade, we also have German real yields that are their lowest in history.
And this may benefit the US dollar, which has recently been struggling near its lows.
For a while last year, German real yields moved back up to be in line with US yields,
and that reduced the attractiveness of the US as a destination for capital.
There are many people who think that the decline in US real yields would discourage the flow of
capital into the US. But the move in European inflation has meant that both the US and German
markets are offering real yields of under -2.5%. Neither, therefore, offer attractive returns,
but in a world where bond funds need to find a home, there will be relative indifference
between these two markets. In previous episodes, we've also seen how the ECB has been expanding its
balance sheet at a faster pace than the Fed. Though in this instance, the euro has tended
to rally when the ECB is being more aggressive and vice versa. So why are bond markets showing
so little interest and could this be a market where yields are preparing to burst higher?
Obviously one of the key impediments to higher yields is the expectation of yield curve control.
The Bank of Japan has been actively pursuing this policy for the last five years. The Fed
has acknowledged yield curve control as a possibility, but without fully committing to
the idea. But in a world where the only policy appears to be an increase in deficit spending
and a huge increase in overall debt levels, then higher interest rates and higher yields
would be crippling for the economy. Therefore, if policymakers are to pursue both loose fiscal
and loose monetary policy, there needs to be a threat that yields will be capped by intervention.
The Fed may never even have to act if the market believes the policy is imminent, if yields did
start to rise and they certainly don't want yields rising too fast. The US budget deficit ballooned
to a postwar record of 20% of GDP. The corporate sector has started to pay down some of its debts
accumulated at the beginning of the pandemic. But there is virtually no sector that would benefit
from higher interest rates, apart from households that have seen a massive increase in savings over
the last 12 months. But it's been well documented that households have not evenly benefited from
the rise in savings and raising interest rates would again widen out income inequality. Higher
yields would also impact mortgage rates, which in the 1970s was one of the major factors that
made inflation then compared to today much more painful. In order to reduce the wealth gap, house
prices would need to fall significantly. The rate rises needed to create that opportunity would have
severe knock on effects across many other parts of the economy. And it's a risk that policymakers
just don't want to take. There is always, however, a positioning risk that an air pocket might
briefly open up in the bond market that allows bond prices to fall and yields to surge. This is
a risk that we've seen all too often across other assets, whether it be the euro's collapse versus
the Swiss franc in 2015, the drop in the front month oil futures last year to -$40 or even the
swift decline in the S&P500 during the onset of the pandemic last year. That also saw both bond
prices and equity prices sell off in unison, which was a major factor in the Fed's mammoth
intervention in financial markets last year. The market therefore assumes the Fed has got its back.
But the key question for investors is whether they can ride out one of those air pockets,
perhaps Put options on a long bond ETF like the TLT is therefore a better hedged for risk
than Puts on the equity market. An implosion of the bond market is one thing that policymakers
cannot afford and therefore the one thing that causes a real catastrophe across financial assets
if they lost control. But there are other reasons why the risk in the bond market may actually be
for higher prices and lower yields rather than a sudden sell off on the back of inflation.
Base effects and bottlenecks have been a major influence on inflation and clearly
ultra-loose policy is also taking its toll. But much of the price action in
inflationary aspects have been driven by market positioning in anticipation of higher inflation
rather than asset prices moving on the back of an increase in demand and true growth.
China has had some success in front running the expected reopening of economies building up its
commodity base when prices were low last year. But comments from Chinese policymakers suggest they
are taking aim at some of the positioning that has been building up. Reflation has so far been more
about the weakness in the dollar than it has about global coordinated growth. Much of the world is
still in some form of lockdown, and parts of Asia are now seeing a resurgence in pandemic cases.
That could create more bottlenecks. But it's not creating more demand. In the US, some states
are starting to roll back wage support, primarily because the workforce remains significantly below
its former level and the participation rate has not yet recovered. Travel restrictions have played
their part, but paying people to stay at home has created employment inertia as well. Once again,
this is not growth. These are bottlenecks. Therefore, it may well be that once we've worked
our way through the stresses and excesses of the pandemic, the new world will look similar to the
old world, where technology continues to eat other businesses and help improve individual levels of
productivity. So far, few businesses have altered their output in anticipation of higher growth.
Many are using the rising input costs as an excuse to raise their own prices and maintain margin.
But this is not really about an increase in demand, but a breakdown in some of the global
supply chains. It doesn't look as if the corporate sector is looking to make any wholesale changes.
Maybe we just need to watch the actions of the corporate sector. Are they planning on
investing for future growth? Throughout last year, cash rich companies that could do buybacks
continued with those programs, and very few looked towards new investment. Broad based buybacks
are again picking up and buybacks arguably helped stifle growth over the last decade.
It looks as if the corporate sector is not planning for a future in which growth picks up.
It looks as if they may be returning to their old tricks. I spoke with Mike Smith from Refinitiv's
Global Sales Strategy and Execution Team about the corporate trends in buybacks and CapEx and what
that tells us about current corporate attitudes towards current growth and inflation prospects.
So what are corporates doing in terms of buybacks and CapEx? And it's key because
this will help us understand the true prospects for future economic growth
and whether it can differ from the pre-pandemic levels. What are you
seeing in terms of trends in both buybacks in the US and also in CapEx at the moment?
Well, Roger, we saw in 2019 and 2020 we saw, you know, the rise of both CapEx and and the
buybacks. They kind of have moved a little bit higher, no gigantic shifts. But then
as 2021 started, everything's kind of pulled back, which is, which is interesting,
2020 was slightly off from 2019. But then the CapEx has pulled back even more as we
moved into the first quarter of 2021, and a lot of what we're seeing from the buybacks
is also an increase in the programs that have been announced coming off of these Q1 earnings reports.
So it's been quite a large shift back into the traditional buyback program and or
shareholder return, let's call it buybacks and dividends. And a theme that I've seen across as
I go through a lot of the calls is 50% shareholder return is what a lot of these companies are
starting to target. So it's an interesting number that's kind of continuously coming up.
And it's quite a decent chunk of the S&P or the Russell
various parts of the indices. These are actually adding up to quite serious sizes again.
Yeah, the numbers behind everything were quite interesting. You're talking I think
it was somewhere north of a hundred companies, a hundred different companies announcing a program.
And then there was another, let's say, hundred or so that were looking at things a little more
strategically, they don't have an official plan, but they're looking to invest where possible. So
it looks like we're going to have an increase, a quite sizable increase in buybacks as we move into
2021 for the rest of the year. We're talking close to 2% of the market cap of the entire S&P 500.
Last year was really focused in a lot of those technology names because they
were the cash rich tech companies. Is it kicking off again this year
that the tech companies are leading the charge in terms of buybacks?
We have the traditional names. You have Apple. Apple's about a $90 billion dollar
rogram announced last quarter, Google, $50 billion dollars. Then you kind of come down. And what's
been actually surprising from the buybacks are that the banks are starting to step in.
So Financials is the number two announced. And what I noticed is they're not going too
far out. So a lot of the other programs that have been announced are for the entire year,
whereas the Financials are only looking the next three to six months because of all the regulations
that they have to follow. But they are the number two. But technology is the largest.
But on the CapEx side as well, I mean, last year,
I think if you look year on year, we started at a better rate. But isn't that heavily skewed to
I think it's the gap CapEx for Verizon. Otherwise CapEx looks like it's flat and no
one's really gearing up for this woo-hoo world of big growth and excitement to the moment.
Yeah, that was the most interesting thing I noticed when going through the data. And you
kind of alluded to that with with GAAP is when we compare our IBES estimates, which come from
the brokers, they look to be non-GAAP and they're not accounting for some of the acquisitions in the
telecom wireless space. So AT&T, Verizon, T-Mobile purchased a large percentage of the
the wireless technology, and that's a huge number that's appearing in the GAAP CapEx.
But after that, it's Amazon has a decent amount of CapEx going into Q1. And you're looking a little
bit at some of the... so GM has had a little bit and I think Ford just announced another one in
addition to their CapEx going into the EV space, so that's really it, it's been quite reserved.
All this inflation talk and all this growth talk, and reflation,
you'd have thought that maybe companies would be going, right we're going to tap
into that by doing more CapEx. But it seems that what they're doing is
CapEx is nowhere. It's not up on the previous year, pre-2020 either. It's sort of flat,
maybe slightly down. Buybacks are coming back. So it seems that although the corporates are talking
a good game in terms of mentioning inflation as a problem or reason to raise prices,
none of them are actually doing anything that suggests they're investing for a long term growth.
It seems like the CEOs are playing this as if it's as if it is transient, that this is just
short term inflation and buybacks and no CapEx will be better for the longer term.
No, I agree. And I think the one of the... I mentioned some of the surprising things when
we were talking about this is even something like energy. So we've seen talks on Real Vision about
oil and some of the squeezes we'll call them there in commodities. A lot of these companies
are still not investing enough in CapEx to drive us into that next level in 2022 to kind of limit
the amount of pricing. Energy has traditionally been a growth area for CapEx. That's where they
did a lot of spending. But they've been bit over the last five years or so where they're, you know,
the pricing is so low and I think they're a little hesitant to spend that money and bring us back
to a normal kind of production level. So I think that's... they kind of have these alligator arms,
as they like to say, they're a little afraid to get out there and get their hands bit off
if they invest too much, they're being very, very cautious with the way they move forward.
This is all suggesting that that reflation story may be not as
robust as we think, whilst at the same time, the tech companies still have loads and loads of cash,
are still doing billions and billions in buybacks. And actually, you know, trying to
fade the tech companies in this value-growth rotation may actually be quite dangerous,
given that this backdrop suggests that actually we'll see a return to tech buying themselves,
buying their own shares, reducing the free flow and pushing the share prices higher again.
Yes, and I think if you look at it, think about it historically, why is a company bought back
is to improve the stock performance. So regardless of what happens as a business,
if they're investing in the retiring shares and increasing the dividends, you know that's going
to attract more and more investors, especially to increase yield. And as people try to find yield,
that's a quite attractive place to put your money is in these tech companies that they're
also - they not only have growth, but they're also giving you some return on that investment as well.
So to summarize, it just seems from the data that we're in this mad world of everything seeming so
completely different and yet the corporate world is actually kind of just carrying on the same,
taking the higher prices where they can. But in terms of how their corporate
style, in terms of longer term thinking, buybacks, CapEx, it all looks like
the old trend is still the old trend, which is the new trend and it hasn't really changed much.
It's back to the old way. All they've done is, if you think about it, they've kind of mirrored the
consumer. They've reduced their debt slightly, but they've increased what's in their savings account.
And they're kind of just waiting to see what happens. I think that a lot of them
are letting this play out and they're going to do what's best for how they're measured.
What Mike is seeing in the data is a corporate sector that seems eager to return to the pre-Covid
trend of buybacks to help performance, rather investing today in anticipation of future growth.
CapEx plans are not meaningfully picking up outside of some sectors which are distorted
by M&A activity. Whilst many are concerned about high yields hurting the tech stocks,
it's these names that are leading the charge in the buyback space, which suggests it's going to
need a particularly big move in yields to dethrone their long term market leadership.