Higher rate pressure on stocks to return

Traders on the New York Stock Exchange floor. Picture: AFP

Over the last week investors have witnessed a global rehearsal of the market forces that will dominate shares and bonds in the coming year.

The United States is being boosted by a stimulus with few parallels in its history.

Not only is there a $US1.9 trillion injection into the economy but Americans are enthusiastically being vaccinated so the worst of the COVID-19 virus is behind the nation; the minimum wage on government jobs is being doubled; oil prices will be forced up; there is a major investment in carbon reduction and a serious shortage of skilled labour.

That boost in economic activity will lift American profits substantially and the share market surge overnight is a reflection of that boom-style outlook.

But with the greater economic activity will come higher interest rates and those rates will accelerate if, as expected, inflation begins to rise. Last week the US 10-year bond rate hit 1.6 per cent and the high yield frightened the share market as well as creating big losses on the bond market.

But the bond yield also attracted heavy buying and the rate settled below 1.5 per cent, which rekindled the enthusiasm of the share market bulls. So last night, we saw a strong rise on Wall Street with unbridled enthusiasm for high technology stocks ---- the shares that were hit hardest by the higher interest rates. Commodities like copper also did well.

Here in Australia the rise in the US bond rate last week sent our 10-year bond rate to around 1.9 per cent and frightened the share market. The Reserve Bank has promised no significant interest rate rises until 2024, which has sent house prices soaring. Seeing the threat from the US, the Australian central bank began buying Australian bonds to push the prices up and lower yields.

Fortunately the buying in the US bond market took the pressure off the Australian bond market and the Reserve Bank succeeded in lowering the rate. But the higher rate pressure will return as the year progresses and we will encounter a re-run of the forces we have just seen.

The Australian market may not perform as well as the US market because there are clear signs that China is taking its foot off the accelerator and that might lower the iron ore price.

But the sheer momentum of what is happening in the US will underpin the demand for commodities. The US bulls like Goldman Sachs say: “Investors ask whether the level of rates is becoming a threat to equity valuations. Our answer is an emphatic ‘no’.

“Our bullish US equity view has already embedded expectations of rising interest rates.”

The bears disagree and say that low interest rates have framed current stock market valuations, which will be hit by higher interest rates.

US analysts say that benefits of the vaccines and the stimulus versus the challenge of higher rates will be the theme of 2021.

If there is a serious US interest rates breakout, the Reserve Bank will be hard pressed to insulate Australia.