JPMorgan equity strategists weighed in on the question of whether the recent decline in bond yields has concluded temporarily or if it might resume later without a significant economic downturn.
In October, the broker advised positioning for a decline in bond yields. However, their recent stance suggests that, tactically, there is anticipated consolidation in the downward movement of bond yields at the beginning of this year.
“We believe that long duration call will stay relevant for 2024, but one is likely to see a pause first, and technically there is even a risk that bond yields bounce, on the exhaustion in negative convexity impact, on potentially more longer dated government bond issuance, and along with likely some more mixed inflation prints ahead,” analysts said in a note.
“In our view, we are unlikely to see another leg lower in bond yields near term unless or until there is a clear deterioration in activity dataflow.”
The implications for equity markets are nuanced. In November and December, the positive reaction to the decline in bond yields fueled a risk-on market rebound. Small caps outperformed large caps during this period due to their high beta nature.
The crucial question now is whether small caps can continue to perform well if the overall market lacks a clear upward momentum, indicating a need to assess the sustainability of their high-beta advantage in the current market dynamics.
“We do not think bond yields will be down from current levels in the near term, which likely stalls the rally, and crucially we do not expect that the decidedly one sided interpretation of why bond yields have fallen, will continue,” analysts added.
Bottom-line, JPMorgan warns that Defensive names could have a catchup if the current risk-on setup changes.