Exposure rates of the Dorval Asset Management Range – 12th February 2021

Investors are naturally raising questions on the risk of excesses, as they almost all agree on the same main scenario of an expected economic recovery along with an acceleration in themes related to the world of the future. The matter of inflation has made a striking incursion to feature among these risks, although it looks somewhat premature at this point (cf. chart 1).

What risk scenario is most likely in your opinion?

Source: BofA survey with global investors (January 2021)



Until recently, economists agreed that the biggest risk was failing to do enough to fuel an upturn in growth – rather than doing too much. However, the debate is shifting. The planned $1.9trn stimulus program in the United States – on top of the $2.3trn plan already approved by the Trump administration in March 2020 and the subsequent December package of $900bn – has stoked fears from some economists of the economy overheating. Secretary of the Treasury Janet Yellen fully owns her choices and is clear that her goal is to restore near full employment in the country in 2022.


Renewed inflation is still a very speculative hypothesis,
even if unemployment revisits 2019 figures
Inflation and jobless rate in the United States

Fed’s long-term inflation target / Core PCE deflator
Unemployment rate


Backing up Janet Yellen’s approach, it’s important to bear in mind that even with a jobless total of 3.5% in 2019 vs. 6.3% currently, the United States had no inflationary tension (cf. chart 2): there was actually insufficient inflation, which was beginning to raise concerns for Jay Powell and the Fed in the event that the cycle would stage a turnaround. So real inflationary risk looks like a very hypothetical situation. The surge in long-term rates over recent weeks actually only reflects a gradual normalization of long-term inflation projections, with real rates remaining stable in negative territory (cf. chart 3). We can envisage a vote in favor of the Biden plan driving a fresh upswing in inflation projections of around 30bps, bringing them into neutral territory. 10-year rates would then move towards the 1.50% mark.


Partial normalization in projected inflation and real rates still at a low

Nominal rates on 10-year Treasuries / Rates on 10-year inflation-linked Treasuries
Neutral area / Projected inflation


A hike in real rates would be required to go beyond this point, and this will no doubt hinge largely on the attitude from the Fed. It previously threw the market into disarray in May 2013 when it announced it would start tapering its asset purchases, triggering a dramatic 150bps surge in real rates. The Fed is no hurry at this point, and it shares Janet Yellen’s goal for a swift and sustainable return to full employment from 2022 onwards. It will wait to see the effects of the Biden package and the vaccination program, as well as their impact on the job market over the long term before making a cautious change in stance.


However, well may we wonder if even a moderate rise in long-term rates should worry equity investors? Many observers have instinctively made the connection between interest rate trends and stock-market valuations, although no stable relationship has been demonstrated for either the market as a whole or more specifically for growth stocks (as we often hear). If equity valuations had followed the drop in long-term rates, world stock-markets would now be trading on much loftier valuations already, as interest rates have hit historical lows (cf. chart 4).


No steady correlation between equity valuations
and long-term interest rates

Rates on 10-year Treasuries (RHS inverted scale)
Shiller P/E for MSCI World (price/average profits over 10 years, LHS)


In our view, the influence of both inflation and interest rates on the equity markets must be analyzed in context. For such times as the ‘vacuum’ created by vaccination campaigns and stimulus plans sustains expectations of an economic acceleration, the rise in long-term rates is only a harmless side effect. However, we realize that investors may take a less rational slant on markets that are already highly optimistic, and use any episodes of swift rate rises as a pretext to sell off some positions. Risks therefore now seem more likely to come from investor positioning and behavioral finance rather than economic aspects and matters of valuation.


We have made very few changes to exposure rates in our flexible portfolios, remaining close to or slightly above neutral position, but with themes that should benefit from expected moves to reopen economies and their ensuing recovery. Our bond positions remain virtually non-existent.



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