Bumps During Expansions Are Typical – July 6, 2021

A recently-published MRB report argued that while the basic narrative for capital markets remains generally positive for risk assets, it embeds inherent contradictions. Risk assets continue to benefit from investor confidence that deeply negative real interest rates can persist along with an historically robust global economic recovery that is gathering pace.

The primary threat to this unsustainable relationship is the inevitable prospect of rising bond yields, whether induced by higher inflation or bond holders’ eventual aversion to capital destruction. The timing of the inevitable re-alignment of the cost of capital (interest rates) and the return on capital (economic growth) will be crucial for investment strategy.

The stock-to-bond (S/B) ratio and other risk assets are sensitive to the ebbs and flows of economic growth momentum, with investor risk appetite usually increasing as growth accelerates and waning as it slows. There were four 15% or greater declines in the global

S/B ratio in the last economic expansion, each coinciding with a growth scare, yet no true bear phase occurred until the pandemic erupted in 2020.


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