• April 5th, 2021
• By Midsilver Investment Limited

During the review period, valuations of risky assets benefited from policy support and generally favorable pandemic-related developments. However, this also led to an uptick in long-term bond yields. With the backdrop of relaxed financial conditions and ongoing monetary support, fiscal expansion prospects significantly influenced certain asset prices. Equities made further gains and credit spreads narrowed, with variations across countries and sectors due to vaccination roll-out disparities. Even though short-term sovereign yields stayed low, the yield curve steepened due to mounting inflation expectations.

Many regions saw stock prices rise, often surpassing their pre-pandemic numbers and in certain instances, reaching record highs. While US companies witnessed profitability growth, relative to earnings, stock prices remained elevated, credited to low-interest rates. In contrast, in Europe, sectors more vulnerable to the pandemic faced valuation drops due to vaccine distribution hiccups.

Echoes of the late 1990s tech boom were felt. Initial public offerings (IPOs) increased, and the trend of platforms designed to identify and list private companies persisted. Moreover, retail investors exhibited unprecedented levels of leverage, speculated on stocks using options, and collaborated on social media to challenge short-sellers. Although cryptoasset funds are relatively new, the influx they experienced underscored a robust risk appetite.

The credit sphere remained vibrant post an impressive revival. While corporate bond spreads experienced a minor widening at the end of January after months of decline, they stayed significantly below historical averages. Debt issuance was robust, especially among those with lower ratings. With bankruptcies in the US remaining low and those in Europe staying under five-year averages—attributed to lenient lenders and policies offsetting the pandemic's impact—investors continued to downplay default risks.

Significantly, the reflation trend gained traction. Long-term government bond yields shot up, despite short-term rates remaining at rock-bottom. The potential for considerable US fiscal intervention, bolstered by new long-term issuance, was a primary catalyst for this yield curve steepening, evident in both Europe and the US. With the Federal Reserve's revised monetary strategy in play, the possibility of fiscal growth prompted investors to factor in increased inflation, without significant dollar appreciation compared to other advanced economies. The ascent in nominal long-term sovereign yields arose from a blend of increased term premiums, heightened inflation projections, and amplified inflation risk compensation.

2021 saw global financial conditions become less accommodating for emerging market economies (EMEs). As the dollar rebounded in January, post the election, on the back of potential US fiscal backing, currencies from EMEs hit harder by the pandemic weakened. Local currency bond yields deviated from their declining trajectory. However, the overarching sentiment towards EME assets remained upbeat. Sovereign spreads for US-denominated bonds continued to narrow. Investors' pursuit of yields was evident from the traction in Chinese bond markets and growth-seeking in East Asia.