We assess the impact of rising bond yields on the UK equity market.
- Rising bond yields have had a pronounced impact on the near-term performance of UK equities.
- We are using current volatility to find opportune entry points for high-quality companies in attractive sectors which are temporarily out of favour.
- We target businesses benefiting from multi-year themes which we believe will ultimately transcend economic fluctuations.
Since the first vaccine approval in November 2020, we have seen an extraordinary divergence of over 15% in the relative performance of so-called ‘value’ versus ‘growth’ stocks in the UK,1 primarily driven by rising bond yields. This is an incredibly sharp move over four months. It is therefore fair to say that bond yields matter for the performance of the UK equity market. The consequence of this has been that stocks dialled into multi-year themes, such as technology and health care, have underperformed more structurally challenged sectors including banks and oil.
What do we do about this? With bond yields influencing equity markets so profoundly, it can lead us as equity investors into the uncomfortable position of trying to second-guess the future movements of the bond markets. We work closely with our fixed-income colleagues, but, as they attest, the problem is that there are many, many variables, which are each challenging to predict. Unknowns include the future words and actions of central banks, the pace of recovery (which itself has many variables including vaccine rollouts and how the Covid-19 virus responds to the vaccines), the ability of governments to smoothly withdraw stimulus without negatively affecting the recovery, and the extent to which inflation takes hold.
We can all take a view as to how we see these factors developing, but ultimately we believe that long-term themes such as ageing populations, digitalisation and tackling climate change are far more certain and more enduring than shorter-term economic gyrations. Markets have already moved a fair way to reflect a post-pandemic world, and while continued expansion in real yields could see further rotation away from thematic stocks in the near term, if inflation does pick up and nominal yields rise to reflect that, it need not be such a gloomy outlook for quality businesses with pricing power which are able to pass inflation through. Overall we believe that, rather than try and chase stocks in sectors without positive thematic exposures, it is a sensible to use this volatility to find opportune entry points for high-quality companies in attractive sectors which are out of favour, unfairly in our opinion.
We believe one such example is AstraZeneca. The company is well known as a global leader in pharmaceuticals, particularly so now that it has produced one of the major Covid-19 vaccines, but what we think is less well appreciated is the level of growth the company is set to achieve in the coming years. A multi-year period of successful research and development (R&D) investment has led to a long runway of growth ahead of it from a diversified range of treatments and geographic areas. Indeed, analyst consensus expects the company to achieve earnings growth of over 20% per annum on average over the next four years. We believe this could prove to be conservative in view of the business’s strong pipeline, track record of R&D success, and lack of significant patent expiries.
The business is strongly aligned with a number of sub-themes from our healthy demand primary theme:
- Personalisation: over 90% of its drug pipeline is being developed with a personalised health-care strategy, which is key to the future of medicine and can create more efficacious treatments with shorter development times.
- Health-care access: over one third of sales are to emerging markets where the expected increase in health-care spending is roughly double that of developed markets.
- Living longer is another sub-theme.Oncology accounts for over 40% of AstraZeneca’s revenue, and is a key driver of growth, up 24% in the 2020 financial year.
We see AstraZeneca as an example of a thematic, quality business with a high growth, low-risk earnings profile which has found itself out of favour as the market has favoured more cyclical names.
So, in conclusion, how much do bond yields matter for the UK equity market? They matter in terms of near-term price moves, but we should not allow ourselves to be distracted from our strategy to invest in those businesses set to benefit from multi-year themes which we believe will ultimately transcend economic fluctuations. The UK is a rich source of these companies, and we think the rotation is providing entry points at compelling valuations.
1 Bloomberg, 16 March 2021 – performance of the MSCI UK Value index relative to the MSCI UK Growth index.
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