What a difference a month has made. ‘Speed of change’ still seems to be the theme. In 2020, we witnessed one of the most aggressive and fastest sell-offs in capital markets’ history, followed by a monumentally strong rebound driven by an abundance of central bank liquidity and fiscal stimulus being thrown into the system. So far this year, it’s the fixed income market that has taken centre stage with an aggressive rise in 10-year US Treasury bond yields from 0.9% at the start of the year to around 1.6% in recent days.
For us, the big questions now are: (1) what happens next, and (2) what does this mean for the environmental solutions space?
Today marks the beginning of three days of bond auctions in the US Treasury market. We think these auctions could be the ‘canary in the coal mine’ for what we think will ultimately be a strong year for equities and not least, a continuation in good performance for environmental solutions companies.
The US Treasury will be auctioning 3-year and 10-year notes and 30-year bonds. We expect these auctions to go well with healthy investor demand after the recent sell-off in the bond market and the concurrent rise in yields.
If these auctions are successful, it could drive down yields meaningfully. Their advance was the main culprit for the extraordinary sell-off we have seen on NASDAQ (growth and interest rate sensitive) and momentum stocks over the last few weeks. On Monday, the tech-heavy NASDAQ index fell by 2.4%, extending the declines from its 12 February high to more than 10%.
Today: US Treasury auctions USD 30 billion of 42-day bills, USD 58 billion of 3-year notes
10 March: US Treasury to auction USD 38 billion of 10-year notes
11 March: US Treasury to auction USD 24 billion of 30-year bonds.
The market’s inflation expectations – with US 10-year breakeven rates at 2.25% – are the highest they have been since 2014. We think this rise has mainly been driven by higher commodity prices. This rise in inflation expectations has in turn driven up nominal bond yields in a thin market with a US Federal Reserve (the Fed) that has been reluctant to step in too early to support the market.
Members of the Fed’s Federal Open Markets Committee are now in their self-imposed ‘blackout period’ ahead of their meeting on 16/17 March. The lack of communication from the Fed combined with worsening liquidity in the bond market has exacerbated the move in yields.
We firmly believe that the Fed and other major central banks around the world are unwilling to jeopardise what has been a historical, coordinated quantitative easing effort to get economies back on their ‘own two feet’.
Indeed, the ECB has stepped up the pace of its emergency bond buying after policymakers issued repeated warnings that the recent rise in yields threatened to derail the region’s economic recovery.
If the US bond auctions go well, as we expect, this should bode extremely well for risk assets including equities, not least environmental solutions companies whose shares have fallen by close to 40% since January.
Having entered 2021 with a conservative stance and holding 10% of portfolio assets in cash, we have not put that to work in what we think is the ‘second bite of the apple’, which should be paving the way for what we believe will be strong performance in oversold conditions.
Many companies in our universe have had an extraordinary earnings reporting season with strong guidance. Many of them are cash-rich, having used the momentum of 2020 to raise capital.
Our core holding sits with USD 5 billion in fresh cash on its balance sheet and is a market leader in the fuel cell hydrogen economy – one of the fastest growing markets today.
Knock, knock… the opportunity is here…. this is the time to add to positions, for medium to long-term investors and for those who the missed the 2020 rally in environmental solutions companies.
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