Bond Investors Caught Up in the Drama
Having reignited tariff concerns, prompting a fall in equity markets on Friday, President Donald Trump tried to dampen these fears over the weekend by delaying the proposed 50% tariff on EU goods until July 9. While the news pushed stock prices higher on European and Asian markets at the start of this week, the dizzying pace of policy change does raise questions about the ongoing credibility of the US as the bedrock of the global economy.
Treasury bonds have been a particular area of concern as they are regarded as the default risk-free asset and act as the foundation of all other asset prices. Evidence of this weakening status can be seen in recent rises in bond yields, which are also reacting to the deficit implications of the tax bill currently moving through Congress.
Looking beyond the rhetoric, a less dramatic picture emerges. Before the global financial crisis in 2008, the current levels of inflation, interest rates, and longer-dated Treasury yields would have appeared normal, with investors able to earn a return of around two percentage points above inflation by owning 10-year government bonds. This relationship was broken in the postcrisis period as central banks intervened in bond markets and Treasury yields fell to a nadir of 0.5% at the onset of the pandemic.
Is the US Dollar Just Becoming Fairly Priced?
The subsequent rise in yields to their present level has been challenging for bondholders and has consequently undermined the role of Treasuries as a source of return and diversification in the minds of many investors. However, in reality, the case for bonds has been strengthened through this period as the pre-financial crisis relationship has been restored, with Treasuries now offering an above-inflation return of around 1.7%, according to the St. Louis Federal Reserve. Although this does not fully negate the risk to the primacy of Treasuries in global capital markets, it reminds us that we should not apply a high probability to that outcome.
Similar logic can be applied to the recent falls in the US dollar. Widely recognized as being overpriced relative to other currencies, the decline in the price of the dollar is far more likely to be a reversion to fair value rather than a harbinger of deeper structural change.
Communication and Tech Stocks
Elsewhere, while the Morningstar US Market Index fell 2.7% last week, most notable was the gap between technology, down 3.4%. and the technology-heavy communication services sector, down 0.6%. These sectors are often linked in the minds of investors as each is home to the Magnificent Seven. However, the current valuation of these sectors is quite different. According to Morningstar analysts, communication services companies are trading at a median discount to fair value of 14.3% compared with a discount of 3.1% for stocks in the technology sector. In an environment where big gaps in valuation persist across the market, there are plenty of opportunities for investors who are willing to think independently and are sufficiently patient to allow an investment to come to fruition.
Tori Brovet recently wrote about some of the opportunities Morningstar analysts are finding in the communication services sector. You can also monitor how the prices of stocks in these sectors compare with Morningstar’s assessment of their fair value.
Could This Week’s Data Spark More Volatility?
This week is packed with economic data that could provide plenty of surprises, including the minutes of the last meeting of the Federal Reserve Open Market Committee on Wednesday, the revised economic growth data from the first quarter of the year on Thursday and the FOMC’s preferred measure of inflation on Friday. Set against the backdrop of ongoing budget concerns and trade tensions, unfavorable readings could spark further volatility.
All Eyes on Nvidia
At a company level, the big news this week is the release of AI bellwether Nvidia‘s NVDA first quarter results on Wednesday. Geopolitics and tariffs are likely to feature significantly according to Brian Colello, Morningstar’s Nvidia analyst. You can read more about what he is expecting from the results here and keep up to date on all the data this week by following this calendar.
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