Over the past year you will have heard a lot about what is driving stockmarkets. You’ve been told that environmental, social and corporate governance, or ESG, matters more than anything; “better” companies provide better returns.
You’ve probably also been told that the pandemic has changed the dynamics of economies entirely. It’s driven relentless digitisation, and changed the way we live and work for good. No one will ever go back to the office full time, shop again at physical retailers, or cook for themselves again. It’s home delivery, forever.
Much of this may be true. But listening to a lot of this guff, it feels as though we have reached a point in the market cycle where everyone is preferring stories to reality. Take food delivery firm Deliveroo, which listed on the UK stock exchange last week. It didn’t go very well: the shares closed down 26% on their first day of trading.
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A lot of people have a lot to say about this. Some reckon it was caused by Deliveroo’s dual share structure: chief executive Will Shu holds shares with 20 times the voting power of others. Some reckon it was about regulatory concerns: what if the company’s gig-working riders end up costing as much as employees? Others say it was about a shift in investor perceptions. As vaccines get to work and lockdowns are eased, the idea we are completely changing the way we live and consume is starting to fray.
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Deliveroo shares were just too expensive
Much of this is clever nonsense. It may seem ridiculous to say so, but the slide in Deliveroo’s share price was not solely about fund managers’ new passion for ESG or any of these other things. It was about the share price.
The company’s £7.6bn valuation, the highest for a British initial public offering since Glencore’s 2011 listing, was simply too much to ask for a loss-making company that operates in a market with few barriers to entry. Deliveroo may be a brilliant, innovative and fast-growing business that will be worth £7.6bn one day – just not this week.
Until a couple of months ago this might not have mattered. Super-low bond yields, which make the lack of income from loss-making companies easier to bear, made many investors value a company’s putative success in the future more than actual corporate success today. Even at the start of the pandemic, this valuation gap between growth stocks and value stocks was at a record high. For most of 2020, it got bigger. In certain fast-growing sectors, company fundamentals and stock prices simply stopped mattering.
Rising bond yields are something of a red herring
So why did Deliveroo’s valuation suddenly matter? One answer is that rising bond yields are now making the market’s more crazed sectors come to their senses. In the last quarter alone, the yield on ten-year US Treasuries has almost doubled to 1.7%. With inflation looking likely, yields may well keep rising from here.
Some may look at this, see Deliveroo as a canary in the coal mine, and rush to sell everything. But just as we must be careful not to extrapolate recent food delivery trends far into the future, we need to be careful not to rely too much on what recently rising bond yields means for markets. It is pretty easy to find periods when rising bond yields have not translated into falling equity prices. Just look at what happened in the 1920s and 1960s, says Calderwood Capital’s Dylan Grice.
In fact, if you examine how equity prices and yields have changed over the long term, it’s hard to find much of a relationship between them at all. Even in really nasty bond routs, equities as a whole don’t always do badly. What matters more is less where bond yields are heading than where equity prices are starting from. Put another way, as bond yields rise, any overpriced assets, such as growth stocks, may well suffer. But anything that is both fairly priced and exposed to economic reopening will not.
The shift from growth to value is under way
Anyone wondering how to invest over the next year should therefore look at what happened in English parks this week. On Monday, two days before the Deliveroo flop, a relaxation of lockdown regulations allowed six people to meet outside – as they did. Anyone seeing those crowds would have sensibly dumped the idea of buying anything involving home delivery and instead rushed to buy assets linked to travel, energy, cars, retail or commodities.
It’s a lesson for the busy bankers at Goldman Sachs and JPMorgan, who mispriced the Deliveroo deal and should have lifted their heads from their spreadsheets to check out the real world instead. The shift to value from growth is already under way: one classic value index, the FTSE 100, is up 21% since the end of October but should have further to go.
There is one more important thing investors should think about. Grice’s analysis may show an ambiguous relationship between bond yields and stock prices, but it does show one clear connection: rising bond yields tend to coincide with rising volatility. So one thing you can be fairly sure about the market over the next few years: it will scare you.
• This article was first published in the Financial Times
