The rise in real interest rates and the slowing growth of money supply are both on our radar this month. Longer term, our team is also keeping an eye on how COVID-19 is exacerbating inequality issues in the United States.
Real rates matter to equities
We're carefully watching U.S. real rates (nominal rates less inflation, which we measure using 10-year breakeven rates) as the've begun to move higher. Real rates have critical implications for a variety of asset classes and equities are no exception: this relationship has strengthened over the past 5 years, and even more so in the past 12 months with certain sectors being highly sensitive to these rate moves. We view real rates approaching positive territory as problematic to equities and would note that sharp moves are more important than small incremental moves.
Real rates and earnings multiples on the rise
Source: Manulife Investment Management, S&P Dow Jones Indices, Macrobond, as of March 3, 2021.
The inequality effects of COVID-19
The COVID-19 pandemic has further exacerbated income inequality in the United States, and we expect the Biden administration to prioritize redistributive policies in the coming months. The Democrats have an ambitious, progressive agenda that will likely include tax increases to ensure at least partial funding for the new spending programs, including the infrastructure bill that the Senate will look to pass during the summer. Incorporating tax increases should allow their policy changes to be permanent (as opposed to temporary COVID-19 relief) and would also serve to redistribute wealth. We expect markets to be sensitive to headline risks associated with tax hikes as the story evolves.
Income inequality in the United States
Source: U.S. Census Bureau, Macrobond, Manulife Investment Management, as of March 3, 2021. Limits are upper limit for the four quintiles and lower limit for the top 5%.
Less money, more potential problems (for emerging markets)
We view the topping out in global liquidity (using global money supply as a proxy) as a tactical headwind for emerging markets equities. Global liquidity has slowed markedly, with the deceleration in balance sheet expansion from the Federal Reserve and the People’s Bank of China being major drivers of this dynamic. In particular, we see declining liquidity as an obstacle for the manufacturing sector, and given that emerging markets still depend heavily on that industry, we caution that the slowing growth of money supply may be a threat to both emerging-market activity and earnings.
Slowing money supply may be a headwind for emerging markets
Source: Manulife Investment Management, Macrobond, as of March 3, 2021.