Quarterly Outlook
Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges
Althea Spinozzi
Head of Fixed Income Strategy
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Danish equities are feeling the heat from interest rates
Peter Garnry
Chief Investment Strategist
Summary: The last two trading days US technology stocks have been impacted by rising interest rates and rising market expectations of Fed rate hikes next year. US technology stocks have interest rate sensitivity due to their high equity valuation, but several other key equity markets such as Netherlands, New Zealand, Singapore, Switzerland, and Denmark are also having high equity valuation and thus high duration. These equity markets would likely underperform next year if the interest rates move considerably higher.
In yesterday’s equity note, we showed how Nasdaq 100 and STOXX 600 are the yin and yang of interest rate sensitivity based on equity market reaction this year with Nasdaq 100 underperforming significantly when the US 10-year yield has a large increase. But outside these two major equity indices, investors felt what higher interest rates can do to sentiment. Danish equities were down 3% in its worst day since March 2020 during the panic days of the pandemic and Dutch equities were down 3.1%.
What do these two markets have in common? They both have equity valuations that are well above many other markets, which simplistically can be translated into higher duration which means that these equity markets are more sensitive to big changes in interest rates. Why is that? Because high equity valuation implies that a larger part of the present value comes from the terminal value on cash flows (meaning way into the future) and this value is more sensitive to the discount rate. Dutch equities are the most expensive of 26 equity markets in the developed and emerging markets with a 12-month forward EV/EBITDA of 23.3x with Denmark and Switzerland less frothy at 14.3x and 14.7x respectively.
If we exclude Australia, India, New Zealand and Singapore from yesterday’s market reaction because of the time delay to the US session then we do observe that equity markets with high equity valuations were hit harder yesterday confirming that we did observe a repricing related to a larger move in interest rates. It is all related to the value vs growth trade which is essentially STOXX 600 vs Nasdaq 100, but which can also be expressed between individual equity indices such as Norway vs Denmark.
The main point of yesterday’s equity note and today’s observations is that we have a group of equity markets such as Netherlands, New Zealand, Singapore, USA, Switzerland, and Denmark that are in the high equity valuation group. These markets have higher interest rate sensitivity and would likely underperform in a rising interest rate environment and exacerbated if flows also favour value over growth. In our view the equity market is telling investors that tail risks are rising for high duration equities and in order to mitigate this investors should begin balancing their portfolios better between high valued growth stocks and value stocks such as energy, financials, and mining companies.
Appendix: 5-year charts of OMXC25 (Danish equities) and AEX (Dutch equities)
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