US treasury yields have risen 70 basis points year-to-date (as of 19 March 2021), with yields nearly 120 basis points above the COVID-19 crisis low of 0.5% in mid-2020 (history’s lowest US yields). The rise in bond yields is now forcing equity and credit investors to assess valuations with a less optimistic lens and is having a larger negative impact on investments with the frothiest valuations. In the past six months, US “value” shares have outperformed large cap growth shares by 14.5 percentage points. This follows outperformance of growth shares by 11.5 percentage points over the prior six months.
Citi analysts expect a 27% gain in global earnings per share (EPS) in 2021. However, rising yields could limit this year’s overall global equity returns to mid- or high single digits. This raises the importance of asset allocation in returns, including selecting the right sectors and country markets, as tactical opportunities become harder to identify.
While reasonably optimistic about continued EPS gains for the “COVID-19 defensive” technology sector, Citi analysts are also expecting “COVID-19 cyclicals” to rebound from their depressed 2020 performance. In contrast, the tech-laden NASDAQ enjoyed sharp outperformance in 2020 with a 43% return versus 19% for both US and global equities overall. Performance is generally shifting to “mean reversion” cyclicals that Citi analysts favor as interest rates rise. The abrupt rise in interest rates is pushing down higher valued “growth” equities more than lowly valued shares that are expected to be most profitable today, rather than in the distant future.
Nevertheless in the longer term, the pullback in high growth and highly valued companies presents an interesting opportunity within Citi’s “Unstoppable Trends”. Investments exposed to themes like increased healthcare spending, 5G & hyper-connectivity, Asian consumption growth and the transition to renewables should represent core allocations in portfolios. The sell-off could also present opportunities to add to long-term growth engines at a cheaper price while future earnings prospects remain sustainable.
Citi’s Global Investment Committee has added to their overweight allocation to UK equites, which have been hamstrung by a heavy cyclical composition of industries most exposed to COVID-19 disruptions. The now largely resolved political uncertainties of the past five years have also left valuations cheap, with shares trading at around 14x 2021 EPS with a 4% average yield. Other regions that are preferred include Emerging Asia, where Citi analysts are long-term positive on Asian consumption, technology and healthcare themes and non-US small and mid-cap equities, which have lagged their US counterparts in the post COVID-19 recovery.