• York Investment & Finance

Global Markets Overview: North America

Updated: Mar 12

By Elliot Sanders, Analyst at the York IFS Global Market Telegraph

Inflation fears hit Wall Street as investors move towards inflation hedged assets.

US equities markets continued their turbulent trajectory in light of inflation fears. The recent slim passing of the $1.9 trillion stimulus deal in the House of Representatives[1] has further stoked inflation fears, triggering a sell-off in US treasuries and further volatility in US equity markets. The high yield and high equity valuation environment has increased the viability of convertible debt[2] and the attractiveness of IPO markets. Bumble became the most recent technology company to list on the NASDAQ with a valuation of $13 billion[3].

US inflation fears have been rising since the start of the year, catalysed by rock bottom base rates, vaccine developments and stimulus. The $1.9 trillion stimulus deal which aims to provide additional unemployment benefits and support for US businesses, is yet another injection into money markets by the Federal Reserve. Money supply in the US economy has risen by 15% since the 2008 financial crisis[4], which has kept inflation above zero in the face of challenging economic conditions. On the one hand, the continued injections are vital to America's economic health, but from the view of financial markets, a threat to real returns due to inflationary fears. Investors on Wall Street have been feeling the pressure to maintain positive real returns. As medium-term inflation expectations have hit a 13-year high[5], US 10-year treasuries have hit 1.55% as investors continue to move out of fixed income.

"Historically rising yields aren't bad for equities. The reason why it's different this time is a lot of equities have high valuations, which are justified by low yields"[6]. As inflationary fears continue, one would expect rising treasury yields in bond markets to be linked with rising prices in US equity markets as investors move into equity markets seeking higher returns. But when the high valuations of US equities are dependent upon a low yield environment, an increase in treasury yields actually does the opposite. Instead of equity markets, investors are looking towards riskier assets, such as emerging markets and junk bonds, as well as markets that typically do well in high-yield environments, such as commodities. Copper and oil, both highly-cyclical and currently constrained by low supply, have continued to surge in price. Copper hit a 10-year high in mid-February[7] whilst oil continues to rally above $67 a barrel[8], as investors question if we are at the start of another commodities supercycle.

A high yield, high equity valuation climate has also had ramifications for the type of financing corporations choose. Inflated equity prices and high treasury yields have increased the viability of convertible debt for listed corporations. A convertible bond is a bond that gives the bondholder the right to swap the debt at the date of maturity for shares in the issuing company at a pre-agreed price. On Tuesday, Airbnb announced a $2 billion convertible bond issue after Twitter and Spotify issued convertible bonds of $1.25 and $1.13 billion each.[9] So far, in 2021, companies had raised a record $34 billion in convertible bonds, 68% more than in the first two months of 2020, when equity valuations and yields were both also high[10]. One would wonder how wise of an investment convertible bonds are for investors when there is an increasing fear that we are in an equity bubble, or even trap and that in the near future, equity values, particularly in the US, will collapse, meaning the conversion to equity will be fruitless. Although true, the companies issuing convertible bonds typically have high-growth potential, which to a degree offsets the risk of an equity bubble. The corporations issuing convertible bonds can be split into two groups, high-growth companies and companies that the pandemic has hard hit.

Nevertheless, even with the potential for high capital gains on these stocks, the high premiums that the convertible bonds have been issued will make substantial capital gains by investors unlikely. Spotify's convertible bonds had a 70% premium on their current share price[11]. Furthermore, with high equity valuations under fire for many of the high-growth stocks issuing convertible bonds, particularly technology stocks, the window for rosy deals may be closing for convertible bond markets.

High equity valuations have also seen increased activity in IPO markets. A key trend in equity offerings in 2020 has been the rise of SPACs in new hubs such as Amsterdam. However, the traditional IPO market has shown no signs of slowing down as the recent Bumble IPO shows. The online dating app successfully listed on the NASDAQ at $43 a share and an overall valuation of $13 billion.[12] In a sign that demand for technology companies is still strong despite a loss of 10% on the NASDAQ in 2021 so far, Bumble ended the day 77% higher than listing at over $70 a share. Bumble said it would use the proceeds to pay down the debt and repurchase shares for pre-IPO owners.

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References: [1] https://www.ft.com/content/d9b95ebe-7a75-4fe5-98a7-1dad28efa252 [2] https://www.ft.com/content/47cafafd-2990-4240-9d53-d7fc64d65010 [3] https://www.ft.com/content/59b22880-22ea-4415-b9d6-8721301d44c9 [4] M2 Money Supply [5] https://www.ft.com/content/53097c24-b13d-4936-8fd9-01517c862efc [6] https://www.ft.com/content/06a4dd1b-ca95-47b2-9cbe-72476d4f2d06 [7] https://www.ft.com/content/c8305fd5-1dda-41cc-a7d2-b1476408ec43 [8] https://www.ft.com/content/771ebf3a-cff0-4ff3-ab9a-0bbd01a33f55 [9] https://www.ft.com/content/771ebf3a-cff0-4ff3-ab9a-0bbd01a33f55 [10] https://www.ft.com/content/771ebf3a-cff0-4ff3-ab9a-0bbd01a33f55 [11] https://www.ft.com/content/771ebf3a-cff0-4ff3-ab9a-0bbd01a33f55 [12] https://www.ft.com/content/59b22880-22ea-4415-b9d6-8721301d44c9


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