Will Bonds Break the Bull? | The Big Conversation | Refinitiv

TL;DR

The ongoing dislocation between valuation and earnings has raised concerns about the equity market's future weakness, with higher bond yields being seen as a potential catalyst.

Transcript

ROGER HIRST: The ongoing dislocation between valuation and earnings has led many investors to question the very nature of the equity market and wonder what could be a catalyst for future weakness. Higher bond yields probably seem very unlikely in the current environment, but many believe that yields are still one of the biggest threats to this fram... Read More

Key Insights

• ❓ Overvaluation is not the reason for a market reversal, as markets can stay over or undervalued for extended periods.
• 🍉 Passive and rules-based funds are dominating the longer-term investing landscape, making sentiment indicators irrelevant.
• 😌 The potential trigger for a market decline lies in higher bond yields, which can undermine equities in the current framework.

Questions & Answers

Q: What is causing investors to question the nature of the equity market?

The dislocation between valuation and earnings, along with the prolonged overvaluation of the US equity market, has led investors to seek out potential catalysts for future weakness.

Q: How have passive funds influenced the investment landscape?

Passive funds, including index funds and rules-based funds, have gained popularity and now dominate the longer-term investing landscape. These funds rely on models and investment rules, making sentiment indicators irrelevant.

Q: How do rules-based funds determine their equity allocations?

Rules-based funds often use inputs such as yield and volatility to guide their equity allocations. For example, levels of realized volatility can define the level of equity allocation, with lower volatility leading to higher equity allocation.

Q: What could potentially undermine the current market framework?

Higher bond yields, steeper curves, and increased volatility in the bond market are seen as credible threats to the current investment framework. These factors could impact rules-based funds and lead to a decline in the equity market.

Summary & Key Takeaways

• The US equity market is currently more overvalued than ever before, with an extended period of overvaluation and active investors underperforming passive funds.

• Central bank liquidity and the rise of passive and rules-based funds have changed the investment framework, making sentiment indicators less relevant.

• The threat to the investment framework lies in the potential for higher bond yields, steeper curves, and increased volatility in the bond market.