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Mar 19, 2021

Inflation and bond market ‘tantrum’ bigger risks than Covid-19, say investors

BofA’s monthly fund manager survey finds ‘extreme bullishness’ on economic recovery, but dangers for stocks

Inflation and the bond market are now seen as bigger risks to portfolios than the Covid-19 outbreak, according to the March survey of fund managers by Bank of America’s (BofA) global research team. 

The research, which polled 197 individuals who manage around $600 bn in assets, finds higher-than-expected inflation is now considered the main tail risk, followed by a ‘tantrum in the bond market’. Disruption to the Covid-19 vaccine rollout is viewed as the third-biggest threat to investments.

During 2021, expectations for a strong economic recovery and higher inflation have led to a sell-off in bonds and rotation from growth stocks to cyclicals. The 10-year US Treasury yield, which moves in the opposite direction to prices, rose this week to 1.7 percent – its highest point for 14 months.

Investors are currently ‘extremely bullish’ on prospects for the global economy, says BofA. Nearly half of respondents (48 percent) are expecting a V-shaped recovery, a rise from just 10 percent last May. 

The survey shows ‘high exposure to commodities, industrials, banks, discretionary [and] emerging markets relative to the past 10 years, which is a drastic 180 [degree turn] from a year ago when investors were heavily invested in defensives like cash, healthcare, staples and utilities,’ write BofA analysts.

In another sign of bullishness, respondents are keen for companies to invest more in their business. More than half (52 percent) say the best use of free cash flow is to increase capital spending, while only 30 percent say it should be used to shore up balance sheets.

The survey also investigates how further rises in bond yields could impact share prices. Investors were asked which yield on the 10-year US Treasury would cause a 10 percent or more correction in stocks – most selected 2 percent. Around a third of respondents say a 2.5 percent yield makes bonds ‘attractive relative to stocks’.

In fact, the Nasdaq Composite has already suffered one technical correction this year when the index fell by more than 10 percent from its high on February 12. The less tech-heavy S&P 500 saw a milder sell-off over the same period and during the following weeks recovered to post all-time highs. 

The BofA research took place between March 5 and March 11, before this week’s meeting of the Federal Reserve, which kept interest rates on hold at near zero. The central bank indicated there would be no rate rises over the next two years, while at the same time revising up growth forecasts for the US economy.