Trump Accelerates Move to a New Era for Equities

The era of ultralow interest rates may be over. This could burst the safety bubble in equities—and create new opportunities in stocks that have been out of favor for a long time.

Donald Trump always intended to shake things up by running for president. But even he may not have realized how his victory would make a profound impact on one of the most stubborn market trends in recent years.

Trump’s promises of a big fiscal boost for the US economy have provoked an accelerated rebound in US Treasury yields. By November 21, the 10-year US Treasury was yielding 2.3%, after having fallen as low as 1.4% in July. And the prospect of rising inflation is widely expected to prompt an interest-rate hike by the US Federal Reserve before year-end, with more to come next year. Yet the recent sell-off in global bonds is just the most visible effect of the post-election shift.

TIDE TURNING IN EQUITIES

For equity investors, a turn in deeper market undercurrents is accelerating. A sustained increase in interest rates would mark a sea change from the market environment of recent years, when a combination of ultralow rates and bursts of volatility fueled a flight to “safer” equities, which might be far less secure than widely believed.

With government bond yields so low, investors flocked to high-yielding equities that are considered bond proxies in sectors such as utilities, real estate and consumer staples. Valuations of such stocks were inflated dramatically, as the explosive growth of passive vehicles pumped money into them indiscriminately.

Even before the US election, there were already clear signs that the safety trade had gone too far and was starting to reverse. Since the election, this trend has accelerated, as the 20% of global stocks with the lowest beta characteristics underperformed the market by 3.9%, amid weak performance in sectors such as utilities and consumer staples.

There are two broad scenarios that can be expected in a rising-rate environment, in our view. First, the sell-off of bonds could lead to a shift toward equities, which could push the markets up broadly and fuel a beta rally. But we believe that this is only a small part of what is likely to unfold.