Equity markets have remained resilient despite a steady rise in government bond yields, but Fidelity WealthBuilder MPS co-portfolio manager Caroline Shaw says investors should pay closer attention to the signals coming from bond markets and consider whether portfolios are positioned for a higher-rate environment.
The unusual combination of rising equity markets and higher government bond yields has been one of the defining features of recent months, prompting some portfolio managers to reassess where they take risk.
According to Caroline Shaw, co-portfolio manager of Fidelity WealthBuilder MPS, strong corporate earnings and continued enthusiasm for artificial intelligence have helped support equity markets, even as bond markets signal mounting challenges.
“There has been an unusual combination in markets over the summer. Equity markets have continued to perform well, with the S&P 500 reaching new highs and corporate earnings remaining supportive. Meanwhile, government bond yields have been moving higher, in some cases reaching levels not seen for many years.”
Shaw says there are clear drivers behind both trends. While economic growth has remained resilient enough to support company earnings, bond investors are having to contend with persistent inflation concerns and rising levels of debt issuance.
“Government borrowing remains high across a number of developed economies, while large technology companies are also becoming significant bond issuers as they finance the enormous capital expenditure associated with AI. That extra supply is one reason we believe upward pressure on longer-term yields could persist.”
While equity markets have so far absorbed the rise in yields, Shaw warns that the relationship may not remain so benign indefinitely.
“Higher borrowing costs eventually feed into mortgages, corporate financing, investment, and consumer spending. If yields remain elevated, they are likely to exert a greater drag on economic activity and risky asset prices.”
Against that backdrop, Fidelity WealthBuilder MPS has reduced risk following strong market performance and become more selective in its equity allocation.
One change has been the sale of a position in US mid-cap companies. Shaw says the original investment case was built around broadening growth beyond the largest technology stocks, but rising yields have altered the outlook.
“Mid-sized businesses tend to be more sensitive to borrowing costs, so we have exited the position and recycled some of the proceeds into larger US value companies, which we believe should be more resilient to any further rises in yields.”
The team has also trimmed emerging market exposure after strong returns, while retaining conviction in selected areas including Latin America, India and China.
Within fixed income, allocations have shifted away from emerging market debt and towards high yield bonds. Shaw notes that high yield issuers currently benefit from relatively healthy credit fundamentals and attractive starting yields, while shorter duration may help cushion the impact of further rises in government bond yields.
Overall, Shaw says the focus is on adapting portfolios rather than making dramatic shifts.
“Growth and earnings remain supportive, so we do not believe this is the time to pivot strongly into more defensive areas. Time in the market remains important.”
However, she adds that rising yields are becoming a more significant consideration for investors.
“After a strong period for risk assets, rising yields present a new potential source of risk. We are taking profits where markets have run hard, reducing exposure to more interest-rate-sensitive areas, and broadening the sources of resilience within portfolios.”
Past performance is not a reliable guide to future returns. You may not get back the amount originally invested, and tax rules can change over time. The writer’s views are their own and do not constitute financial advice.
This information should not be relied upon by retail clients or investment professionals. Reference to any particular investment does not constitute a recommendation to buy or sell the investment.
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