Markets spooked as bond yields rise – here's what investors should do

A sharp sell-off in government bonds has spilled over into stock markets with experts urging investors to review their portfolios.

Yields on government bonds, which move in the opposite direction to prices, have surged this week, with fears over an upsurge in inflation gripping investors.

The yield on 10-year American government bonds, a crucial benchmark for the global price of borrowing, jumped above the 1.6pc mark yesterday for the first time since the onset of the pandemic.

Fears of spiralling inflation, as economies reopen and pent-up consumer demand is unleashed, have driven investors away from government bonds. In America, those worries have been super-charged by president Joe Biden’s looming $1.9 trillion (£1.36 trillion) stimulus package.

This is bad news for bonds as it eats into the value of their fixed coupons. Any jump in expectations for the rise of the cost of living tends to send their prices lower, and yields higher.

The bonds sell-off caused ruptures in the stock market, with technology stocks and shares in other fast-growing companies hit hard. America’s tech-heavy Nasdaq index is down 5.4pc this week and fell 3.5pc yesterday, its biggest drop since October.

Shares in Britain’s biggest investment trust Scottish Mortgage, an enthusiastic backer of “growth” companies like electric car maker Tesla, e-commerce behemoth Amazon and Chinese tech giant Tencent, are down 15pc this week.

Growth stocks have born the brunt of the sell-off as the prospect of higher inflation eats into the real value of the the future profits for which they are prized, according to Jason Hollands of broker Tilney.

The shift could have a big impact on British DIY investors, who have flocked to growth stocks and funds. Mr Hollands said investors should examine whether they held too much of their portfolios in such investments.

“A lot of investors are very driven by past performance and keep investing in growth funds because those are the ones at the top of the performance tables,” he said.

“The next five weeks of Isa season is the peak time to be thinking about their investments. The first thing they need to consider is whether they have too much exposure to growth funds,” he added.

Mr Hollands suggested investors could “correct that imbalance” by buying more British stocks and funds.

Other areas of the stock market have flourished. Shares in companies worst hit by lockdowns have soared with retailers, travel companies, restaurant groups and airlines leading the way.

The commodities market is booming, with the oil price up by a third since the turn of the year and the prices of major metals soaring on the prospect of greater economic activity.

"Brexit issues have obviously faded and the UK market, which was the laggard last year and heavily exposed to more cyclical areas, has a lot of bounce-back potential,” he said.

Laith Khalaf, of broker AJ Bell, said bond investors should also reassess and those holding them for income should look at high-yielding investment trusts that buy shares, such as City of London.

Bonds’ appeal as a safe haven investment had waned, he added. “Some investors choose bonds because they have low volatility. However, one has to question whether a high allocation to bonds right now is actually an accident waiting to happen.”

For government bonds, the impact of rising inflation expectations has been magnified by the ultra-low yields they were offering. These had been driven down by huge global stimulus from central banks to contain the economic damage caused by the pandemic.

The yield on 10-year American government bonds, which started last year at 1.88pc, crashed to an all-time low of below 0.4pc in March. Now investors fear central banks will start withdrawing the support that has propped up both the bond market as lockdown eases, according to Mr Khalaf.

“A recovering economy means central banks don’t have to offer as much stimulus and at some point this year, they might even start whispering gently about whether to withdraw quantitative easing or raise rates.

“Kicking away this crutch will inevitably lead to a fall in prices. Markets will look to pre-empt central bankers and that’s probably what we’re seeing now.”