Turning to markets, a decline in U.S. Treasury yields and improving corporate earnings provided support to equities. In the U.S., around 87% of S&P 500 companies have beaten estimates for the first quarter, with just under one-fifth having reported.
Volatility in financial markets hit their lowest levels since the pandemic hit stock and bond prices last year, as investors bet on a successful reopening trade and optimism on a strong earnings recovery. The Vix index, which measures implied volatility on S&P 500 index options, has dropped below its long-term average of 20 ending the month at around 17.6. Whilst volatility measures remained subdued, the change in corporate prospects since the discovery of vaccines has meant investors have returned to banking, travel, energy and hospitality sectors with lockdown winners relinquishing market leadership.
Equity market valuations continue to operate at lofty levels. The market P/E ratio, as determined by the MSCI AC World Index, remains elevated at 29x and Tobin’s Q, the ratio of total stock market capitalisation to the total replacement value of the assets in its companies, is at an all-time high. One argument justifying equity market valuations is that the bond market is also historically expensive and when this is considered, equities don’t seem so expensive. Bonds were at their most expensive during the worst of last year’s Covid shutdown, with the decline in yields supportive of growth equities. However, given the sharp rise in bond yields and climbing equity valuations the earnings yield argument has weakened considerably. Despite the move in bond yields, we remain of the view that longer duration bonds continue to be expensive preferring to position ourselves at the shorter end of the curve where interest rate risk is lower.
Investors remain on alert for signs that the Fed will consider reducing its $120 billion monthly bond purchases earlier than anticipated. Such concerns came to the fore when the Bank of Canada became the first G7 central bank to scale back its pandemic-era bond purchases by C $1 billion a month to C $3 billion. The move from the Bank of Canada prompted the ECB to highlight the obvious. That is such tapering would be premature for the Eurozone given the delay in rolling out the vaccine although some progress has been made of late.
After the worst quarterly return since 1980 the U.S. Treasury market has seen yields tighten despite the U.S. expecting stellar economic growth over 2021. The benchmark 10-year yield fell to as low as 1.56%, rallying by 19bps before widening to end the month at 1.64%. Much of the decline in the U.S. 10 year has been attributed to demand from overseas investors.