(Claire Willemse – Vice President of UCLIF)
Welcome to the UCLIF Analysts’ Insights, a weekly newsletter that brings you some interesting feature reads and unique perspectives from the Analysts at UCLIF!
Treasury Yields, the Fed and US Markets – What does it all mean?
The US Federal Reserve held its most recent meeting this Wednesday, 17/03/21, and helped calm the US equity markets that had become troubled by rising treasury yields. The reasons behind these market shifts can seem distant and complex – so let’s have a look at the last 2 weeks to really understand what happened, why it happened, and what’s next.
Firstly, what’s happened in markets?
Over the last 2 weeks, US equity markets have been extremely volatile – especially tech and growth stocks. From March 1st to March 4th the $SPX fell almost 5%; just 10 days later it hit an all-time high of $3983.87.
Why did markets decline?
The large general decline in US stocks, especially declines in growth stocks that have seen large runups like $TSLA, has been awaited by many – after all, how long can such a strong bull market last? However, the downwards move was not simply a change in investor sentiment. The catalyst was treasury yields.
Due to rising inflation expectations and confidence in the economy’s recovery, the yield on long-term yields reached 14-month highs of 1.7% and 2.4% for 10-year and 30-year bonds respectively. This is because investors are making ‘reflationary trades’ and expect interest rates to rise.
The reason that this is all causing shifts in US equity markets is because extremely low interest rates have been one of the key driving forces in the recent asset price increases; if investors expect interest rates to rise then this causes a shift away from the expensive tech/growth stocks that are being propped up by low rates. Instead, value stocks and securities that are tied to economic performance become more attractive.
This rotation was the catalyst for a drop in tech and growth stocks that dominate the weight of the $SPX. Another interesting note was that retail investors ‘bought the dip’ instead of selling into the crash, this is why the dip was so short despite its size.
Why has there been a large recovery?
After the Fed’s meeting on Wednesday, it was made clear to markets that interest rates are expected to be held at low levels for the next 3 years. Jerome Powell also said that the government will continue with its bond-buying program. These ‘dovish’ messages helped prop up the large blue chip tech stocks that had fallen 5-10% in a few days. Many investors are also taking a longer-term approach, observing the fact that the trend of lower rates has been continuous for the last 30 years.
With each passing week the dizzying prices of many large US tech stocks seem to face some new challenge and then prevail at higher heights. The fear of inflation seems high but seems somewhat overblown – trends of deflationary technology and stable productivity levels have kept inflation low so far.
There has been a spill-over into foreign equity markets and energy markets from inflation expectations but this does not seem strong enough to pull down this strong bull market.
I expect the rotation from growth to value stocks to increase at a greater pace, but with relatively strong support from the Fed and generally bullish sentiment there could still be room to run higher.
Global Semiconductor Glut
A worldwide chip shortage continues to pummel carmakers and electronics manufacturers and threatens to hamper a post-pandemic economic recovery. General Motors announced that it was shutting down plants in February and Volkswagen cut production by 100,000 cars due to the chip shortage. Samsung Electronics is considering delaying the launch of its new Galaxy Note and the world’s largest chip manufacturer Taiwan Semiconductor Manufacturing Co. is on backlog for the next 6 months. Consulting firm AlixPartners expects the glut to result in $60.6 billion of lost revenue for the automotive industry in 2021.
It all began in the first half of last year, when semiconductor manufacturers halted production following COVID-19 lockdowns. Meanwhile, demand for chips rebounded swiftly, as remote work led to surge in demand for laptops and gaming consoles, coupled with secular shifts toward cloud computing and 5G. The growing trend towards electric vehicles also raised the automotive sector’s chip demand. Worldwide semiconductor revenue grew 5.4% year-on-year to $442 billion in 2020, and is expected to grow by a further 7.7% to $476 billion in 2021.
Chip manufacturers are finding it difficult to close the demand-supply gap, as lead times are up to 26 weeks on average. The sector operates on a horizontal configuration where production and development are done separately, and time is needed to reconfigure semiconductors according to different specifications. There is also little competition in the semiconductor manufacturing market, because high capital expenditure serves as a barrier to entry.
Delivering on his election promise, President Biden has called for $37 billion in funding to boost US semiconductor manufacturing. Taiwan Semiconductor Manufacturing Co. has increased its capital spending budget to $28 billion this year.