Market and Economic review for week ending 7 May 2021
Within the LF Prudential Risk Managed Active and LF Prudential Risk Managed Passive portfolios we maintain an overweight position across a range of equity markets including UK, Europe, US, Japan, China, and Asia. A small emerging market debt overweight position remains with an underweight in US investment grade as a result.
Market and Economic review
The short bank holiday week started with a sell off across equity indices when investors absorbed the statement from Janet Yellen speaking at an interview, where she was quoted ‘interest rates may have to rise to prevent ‘overheating’’. With a weak start already in Asia and Europe, US equities accelerated the trend lower, with rate sensitive tech names leading the Nasdaq down by over 2%. Fast forward two hours and she had completed a volte-face claiming that she was not predicting or recommending increases in rates. In our opinion this was a planned test to see the strength of asset markets resolve against the hint of tightening rhetoric, a test that Janet and perhaps by extension the Fed, seemed to have concluded the markets failed given the reverse tack. This all demonstrates with a possible impulse in inflation coming shortly, the Fed will be walking a fine line between being accommodative due to the pandemic and the pressure on yields a demand surge could create, as lockdowns continue to be lifted. Some data seems to be confirming this with the US producer price index rising 4.2% year on year, the highest reading since 2011, as well as the US ISM manufacturing prices index increases.
About eighty percent of the S&P 500 companies have reported for Q1 so far, with robust earnings surprises across all sectors. With a vaccination plan going well and some parts of the country fully re-opened, the consumer discretionary sector surprised positively the most with 68% of companies so far beating analyst earning expectations. Energy, financials and communications came second with around 35% of companies beating expectations, which bear the hallmark of a cyclical impulse post a self-induced recession. However, even after such positive numbers, the US equity market has traded sideways recently, as the recovery trade seems to have been priced in. Investors are looking ahead to see if this momentum can continue with favourable fiscal and monetary conditions.
On the other side of the Atlantic the UK has started it’s slow return to normality, where some indicators are also showing extraordinary rebounds in economic activity. Although from a very low base, new car sales for April were up a record 3,176.6% and the Markit Composite PMI reported a reading of 60.7 vs 56.4 a month earlier. The Bank of England met on Thursday and still remain accommodative with no change in interest rates and quantitative easing. The commodities upswing continues with rallies across most assets, the most noteworthy being lumber where it has increased five-fold in 1 year reaching all-time highs of over 1600 dollars per 110,000 board feet (the metric used to measure 1 futures contract). Copper and crude oil have also retraced their 2021 highs and although this will undoubtedly affect the US CPI number, how much this spills over into the non-food and energy measure of core CPI that the Fed monitor remains to be seen. However, as previous commentary has noted, the Fed believe this will be a transitory effect and will be ‘looked through’.
In the Euro area, although the after effects of lockdowns kept the manufacturing PMI relatively subdued at 62.9 versus estimates of 63.3, the number is still firmly in positive territory and retail sales came in at 12% year on year to March compared to -1.5% in February. This could lead to an economic bounce in the short term and boost European earnings which have lagged the US so far, under an optimistic inoculation roll-out.
Sadly, the virus continues and the effects are even more pronounced in India currently, where record daily cases and deaths are being reported. Bad messaging, inadequate medical infrastructure, vaccine production issues, along with large swathes of the population that need physical economic interaction for sustenance, have led to perfect conditions for virus transmissibility and mutation to occur. A global response is desperately needed for the sake of the Indian population and more globally in terms of new strains, where Public Health England (PHE) have highlighted the Indian variant to be a ‘variant of concern’.
China continues to grab headlines for the wrong reasons this week, with two notable events that took the spotlight away from trade tensions. The first is a 21 tonne piece of Chinese space debris that will fall back to Earth this week with disastrous implications if it falls somewhere populated. Nasa believes this to be a cavalier attitude on deorbiting space junk, as they believe the Chinese haven’t shown the same regard as the US has, in dealing with potentially fatal falling debris. The second is more planned, where they had yet another incursion into Taiwanese air space with military aircraft, the 21st incursion since the beginning of April and at record levels compared to history. The economic show of power is also being matched by hard power for political signalling directed at Taiwan and the US.
Next week we have a slew of economic data including UK GDP, US, German and Chinese inflation and various sentiment indicators from around the world. The inflation numbers will be keen reading and MAPM will observe the tight-rope the Fed walks in terms of their messaging, with the backdrop of a broad global economic upswing.
We continue to believe that we are in a synchronised cyclical recovery as evidenced by macroeconomic data and this is likely to be boosted by increasing fiscal spending in the US. We remain underweight fixed income (predominantly a duration view), as we think the risk to rates is on the upside. As we saw in early Q1 and this week, the speed at which rates rise and unexpected tightening rhetoric (even if due to positive growth and inflation) can negatively impact equity market sentiment – but for now rates seem to be edging higher under a positive macro backdrop.
T&IO Weekly Market Update Podcast
Dean Cook CFA, Portfolio Analyst in the Multi Asset Portfolio Management Team at T&IO talks through this week’s latest market developments and T&IO’s current outlook.