Are we soon to see a soaring stock market?

With bonds less attractive to investors, money could flow to the stock market instead, driving up share prices.

The content of this article was relevant at the time of publishing. Circumstances change continuously and caution should therefore be exercised when relying upon any content contained within this article.

Hand arranging wood block stacking as step stair on paper pink background

Image source: Getty Images

When investing, your capital is at risk. The value of your investments can go down as well as up and you may get back less than you put in.

Read More

The content of this article is provided for information purposes only and is not intended to be, nor does it constitute, any form of personal advice. Investments in a currency other than sterling are exposed to currency exchange risk. Currency exchange rates are constantly changing, which may affect the value of the investment in sterling terms. You could lose money in sterling even if the stock price rises in the currency of origin. Stocks listed on overseas exchanges may be subject to additional dealing and exchange rate charges, and may have other tax implications, and may not provide the same, or any, regulatory protection as in the UK.

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More.

Global bond markets have been twitchy in recent weeks – and during the second week of March, that twitchiness turned into a rout.
Over just two trading sessions, the yield on United States 10-year treasuries – a popular benchmark – jumped from 1.48% to 1.62%. Here in the UK, 10-year gilts also spiked sharply higher.
And when yields rise, don’t forget, that means that bond and gilt prices are falling: a fixed-income sell-off is under way.

Inflation ahead?

It’s not difficult to see why a sell-off might be occurring.
Fixed-income investments – bonds and gilts – deliver, as their name implies, a fixed income. Compared to shareholder dividends, it’s an income that is more stable, more resilient, and more predictable – but also fixed: the price that you pay for a bond or gilt at the point of purchase determines the return that you get.
And that fixed return means that periods of inflation can sharply erode the real after-inflation income from holding bonds and gilts, making them less attractive to investors. Which is what’s driving the sell-off: fears of significantly higher levels of inflation.

Flush with cash

Markets – both fixed-income and equity – have in fact been twitchy about inflation since December. Again, it’s not difficult to see why.
Let’s start with household cash balances. The Covid-19 pandemic has had sharply different outcomes for many people.
Yes, the media is full of stories of people on furlough, and small business owners unable to open for business – think shops, pubs, restaurants, and so on. But many other people have continued to work, and find themselves building up significant cash reserves with little opportunity to spend that money.

Here in the UK, household cash balances rose sharply during 2020, increasing by another £21bn during December. That’s on top of some fairly hefty debt repayment, with household net debt falling by £16.6bn – a lot of it coming from outstanding credit card and mortgage balances.
The story is similar in the United States: in December, US household wealth hit a record $123.5trn, and again, credit card debt fell significantly, reducing by $149bn during 2020.
Put another way, when shops, pubs, and restaurants do eventually reopen, and it once again becomes possible to book holidays and visit car showrooms, an awful lot of people are going to find themselves with an awful lot of cash to spend.
Does that sound inflationary to you? It does to me.

Tsunami of money

Now on top of all that cash, let’s throw in the economic stimulus measures that governments around the world are launching.

Here in the UK, the latest Covid-19 support measures that chancellor Rishi Sunak announced in the Spring budget have seen 2021’s projected levels of government borrowing leap to £355bn – a level that is unprecedented in peacetime. Furlough payments, help for the self-employed, cash grants to shops and hospitality businesses, various business rates holidays, a lower rate of VAT for hospitality businesses: the chancellor’s largesse seemingly knows no bounds.

Over in the United States, President Biden’s $1.9trn stimulus package is just as generous. Europe, too, is getting in on the act. Governments everywhere are spending, trying to kick-start pandemic-ravaged economies.
Quite simply, it all adds up to a giant tsunami of money, heading straight for the economies of the countries in question.
And does a giant tsunami of money sound inflationary to you? It does to me.

So what does all this mean?

Several things.
First, if inflation does indeed ratchet sharply upwards, expect bond and gilt yields to rise even higher – in other words, the sell-off will continue, until yields once again offer realistic real after-inflation returns.
And if sustained, that bond sell-off is going to see a lot money needing a home. I don’t know about you, but I reckon that this spells good news for share prices. Plus, unlike fixed-income assets, shares offer returns that have a degree of inflation-protection, further adding to their appeal.

Moreover, an inflationary environment will serve to make growth-centric shares relatively less attractive compared to income-centric shares – just as we’re seeing in the depressed valuations of several leading technology stocks right now.
The obvious beneficiaries of all this? Higher-yielding, boring, defensive consumer-oriented stocks – just as the consumers who are their customers find themselves flush with cash, adding further impetus to share price growth.
The message is clear: for investors, it’s going to be an interesting summer.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

More on Investing Articles

Satellite on planet background
Investing Articles

At just under £14, can BAE Systems’ share price still be a prime FTSE 100 bargain? 

Despite its bullish price run, BAE Systems’ share price still looks undervalued to me and appears set for strong growth.

Read more »

Photo of a man going through financial problems
Investing Articles

2 dividend shares I’d avoid like the plague in today’s stock market

The UK stock market is full of high-yield dividend shares that could equate to a steady stream of passive income.…

Read more »

Abstract bull climbing indicators on stock chart
Investing Articles

£17,000 in savings? Here’s how I’d aim to turn that into a £29,548 annual second income!

Generating a sizeable second income can be life-enhancing and can be done from relatively small investments in high-dividend-paying stocks.

Read more »

Investing Articles

With as little as £300 a month invested, this stock could net £16,000 a year in passive income

Putting a few hundred pounds each month into the stock market could eventually generate a five-figure annual passive income, this…

Read more »

Black woman using loudspeaker to be heard
Investing Articles

This dividend stock could pop next week!

This dividend stock happens to have one of the biggest dividend yields I've come across -- 10.7% -- but I'm…

Read more »

Investing Articles

Up 81%, can this FTSE 100 turnaround share keep surging?

This recovering retailer has been one of the FTSE's greatest performers over the past year. Royston Wild considers whether it…

Read more »

Happy couple showing relief at news
Investing Articles

£10,000 in savings? I’d buy 4 passive income shares to target a £100 per week second income!

By buying passive income shares today, I have a great chance to eventually make life-changing wealth. Here's how I'd invest…

Read more »

Man writing 'now' having crossed out 'later', 'tomorrow' and 'next week'
Investing Articles

I think this may be an unmissable chance to buy an oversold UK share before it rallies hard

Harvey Jones piled into this beaten down UK share because it looks cheap and offers a sky-high yield. Now he's…

Read more »