Market Pulse | Goodbody Wealth Management: Recent Episodes
Goodbody
A concise overview of the key themes driving financial markets and investor decisions around the world.
• Inflation was centre stage last week with the core figure in the US just missing the 5% level. For once it was not higher than expected, and that was a bit of a relief. The other positive that was taken from it was the decline in the month-on-month rate i.e. we are passing the peak.
• The Fed meets this week and the expectations are that it will announce accelerated tapering, with net buying to be completed by March next year, and that the ‘dot plot’ will be brought forward by a couple of quarters. Expectations have moved to a relatively aggressive statement from the Fed. Post the ‘Powell pivot’ of the week before last some of the investment banks have revised their interest rate forecasts.
• As we approach year end the background remains equity friendly. Earnings are still being revised upwards. These have been acting as the perfect inflation hedge -as inflation has been accelerating in the second half of this year so has earnings growth. The Q4 reporting season will be kicking off in 4 weeks and the signs are that it will be another very strong quarter. In China the authorities are beginning to implement policy changes instead of just talking about them.
• The Powell pivot became the major talking point last week. During his testimony to Congress he said that the Fed does need to talk about a faster rate of tapering. He also pushed inflation concerns up the agenda. No doubt part of this was in response to the White House putting tackling inflation as a priority. As a result, there was a meaningful increase in interest rate expectations over the week.
• The encouraging thing from last week was the reaction of the fixed income markets. Our fear has always been that as we moved towards normalising monetary policy, there could be a lot of volatility in the bond market which would undermine all asset classes (an interest rate scare). That did not happen last week. Yes, there is a bit of pain in the short end but longer dated yields fell and that is what is important to other asset classes.
• Of course, Omicron is in the background and there is risk that its spread causes dislocation in the global economy. Perhaps this is what the bond market is thinking. One problem with this thinking is that if the dislocation does become significant then monetary tightening probably goes off the agenda. The Delta variant did cause some turbulence in the global economy and in equity markets but the growth rate remained high and the impact was short lived. Using that as the ‘playbook’ it says stick with your long-term strategy and that is what we will be doing and looking at last week’s reaction in the fixed income makes us a little bit more comfortable about that.
• Covid and the new variant will be the main focus in the short term. The reopening theme was already under pressure as infections were rising rapidly in Europe and this gained further momentum on Friday with some very extreme moves in prices.
• This should not impact too much to views on asset positioning. Policy makers will remain very supportive, which is important, and the experience with the Delta variant has been quite benign. Friday was a shortened trading day in the US but the equity market it saw the second largest daily inflow this year from retail investors.
• The equity mix is the more pertinent question and the hit to the reopening trade is a painful journey. But it seems like a lot of bad news has been priced in now so without some firmer information it would be difficult to add value reacting to the developments.
• Last week we were still getting good indications on economic performance. The US is still leading. High frequency indicators (restaurant bookings, passenger traffic, credit card sales etc) were all back to new highs for this year. In fact, it looks like we are back into an upgrade cycle for the US economy although that should not last too long. There were also indications that China would start more efforts to support the economy Premier Li called on the provinces to step up infrastructure spending and the PBoC said it would be doing more to stabilise the credit market. The global economy looked set to have a quite strong finish. This was feeding into earnings as well. We are still getting upgrades, even in the euro area where the outlook has become most clouded. Earnings growth for 2021 was pushed up 1% over the last week. The environment remained very equity friendly.
• Covid became the story that the market was once again following closely last week, with a rise in infections in Europe. Reopening stories were under pressure and the return to normality for these companies looks likely to be impacted. The markets also saw the shift to quality within equity markets, which is due to how companies are managing the cost and supply pressures which they face.
• Many Investment Banks are producing their outlooks for 2022, including Bank of America where it has turned aggressive on the timing of interest rate rises, with an interesting feature of it forecasts being the pace and the peak. It is expecting a 0.25% increase in Fed Funds per quarter and the peak to be between 2.0% and 2.25%, which can result in a benign interest rate cycle. There is not much expectations for downside left in fixed income markets and little disturbance for equity markets.
• It was a better week for data with very encouraging figures from the US. Strong figures within retail and industrial production, as it could indicate that we are passing the worst in the impact of supply chain rigidities. It was a flat week for index levels, and this was the US statistics that came in strongly and will offset any turbulence in the EU area which will push us on into 2022.
• Economic data last week was dominated by the CPI release in the US showing continued inflationary pressure in the US economy. Market reaction was relatively muted. A lot of this relatively calm reaction is probably due to the Fed saying it will not be making any judgement about how permanent the inflation pressures are until the middle of next year.
• We think that we will see a peaking in the year on year growth rate in the global economy as the reopening impulse fades in Europe and the US plateaus from its Delta variant rebound. As we travel into 2022 economic growth will remain elevated but at a slower pace than we are experiencing now. Thus, we feel it appropriate to move some more of our equity exposure to mid-cycle type names.
• Interest rate expectations faced a reversal last week, with two trigger points being the Bank of England meeting and the Fed’s Powell commentary on how transitory the inflation forces are. This pushes the expected interest rate increases in the US out towards Q4, which gave a spur to all asset markets.
• Q3 earning season continued again last week, with US earnings growth coming in at 40% year on year, and in the Euro area, we are getting 50% year on year earnings growth. They are not as strong as they have been in previous quarters, which is coming from very strong sales growth. Companies are facing supply chain issues and cost pressures, however demand is very strong that they are able to cope with pressures and produce results.
• This all leads to a positive outlook for the end of the year, which is motivated by the US economic performance, calm fixed income markets and an earnings story, with a potential for upgrades. The market may face disruption from China and closer to home via ongoing UK-EU negotiations.
• October was a very strong month for equity markets but there was a large regional bias. Developed Markets did far better than Emerging Markets. Some of this is due to the uncertain outlook for China both in terms of growth and policy and some of it is due to sporadic lockdowns due to the pandemic.
• The most striking feature over the last week was the movement in longer dated bond yields in the US and the euro area. For maturities between zero and ten yields there was still upward pressure on yields but at maturities of 20 years and more yields declined by 15bps in both regions. This was driven by expectations of interest rate increase being brought forward into 2022 – we think this is too aggressive.
• For equity markets it does re-enforce the need to be moving towards mid-cycle type exposure. While October was a month for cyclical exposure, that did fade during the last week and one saw the higher rated parts of the equity market beginning to perform, quicker than we would have expected. Last week reinforces the view that we should keep our portfolio preferences biased towards structural and sustainable growth (Healthcare, IT, Services, Consumer) and away from companies and industries that are reliant on the level of economic growth (such as Materials, Manufacturing).
• We got inflation updates from the US which were also somewhat encouraging. Both CPI and PPI came in below expectations. In the CPI report we did see some of what we hoped were transitory pressures (Travel and Lodging, second-hand car prices) subside. On the other hand, there is upward pressure on property costs which will be more sustainable. So, we are likely to have a higher level of inflation but not at some of the extreme levels we have seen in recent months.
• China is a bit more mixed. Q3 GDP missed forecasts as did Industrial Production but much of this occurred in September as power outages spread. So, the weakness is not due to lack of demand. On a positive note, Retail Sales accelerated in September as the number of lockdowns declined.
• The reporting season will capture more of the headlines over the next few weeks and the start has been promising. The consensus forecast is that Q3 earnings for the S&P 500 will be up 30% YoY, 11% higher than at the start of the year. Even over the last four weeks this was increased by 1.6%.
• What we have seen over the last week supports our positioning, a strong growth background with easing in inflation pressures translating into very strong earnings growth. Equities benefit and bonds remain reasonably well behaved. What could derail it is the rampant energy prices and power supply issues. Governments seem alert to the potential growth impact so policies will be implemented to alleviate income pressure from the higher prices. Supply response has been muted so far but that could change and normally does.
• The third quarter was more subdued than the previous ones. Equities ended the quarter on a weak note, but still eked out a small positive return for the full quarter. Bond markets also had a tougher end to the quarter delivering a flat performance for the overall.
• This quarter was the first this year where GDP forecasts for 2021 were reduced. Global GDP growth was cut from 6.0% to 5.7% driven by cuts to US and Asian forecasts as the Delta variant impacted on consumption and production in Asia. Profit expectations remained robust with 2021 earnings growth increased from 39% to 48%. Europe saw the biggest upgrades and by sector it was again Industrials, Energy and Materials that led the way.
• Some of the factors dragging on markets in late Q3 are likely to reverse or have less of an influence through Q4. Rampant energy prices could undermine this and this remains a concern but any easing in energy prices here would clearly be a major positive.
• There were three issues on peoples mind coming to the end of the quarter; the main issue being the Fed’s announcement in November about the tapering time table. This has driven bond yields up and 10-year yields to rise between 10 and 20 basis points, putting pressure on equity markets. Both the fixed income and equity markets have been unsettled with China’s Evergrande, would it cause financial contagion? Lastly the spike in energy and power prices has fuelled the inflation pressure around the globe.
• Asset prices are lower, previously there was possibly an element of complacency. Other developments have made us more comfortable. If we travel back to August, we would have worried about the Delta variant disrupting economics, however the releases for September show the Chinese and Asia X China PMI’s back at or above 50, moving back to expansion territory. In the US, a strong Manufacturing ISM and improvement in data such as restaurant bookings and credit card transactions shows the with the economic background looks better than the previous month. The Q3 reporting season should give some support as sentiment is fairly low at present
• Portfolio strategy remains overweight equities as economic expansion in place. News of the Delta variant slowing and news of a possible oral antiviral treatment gives another boost to the reopening. Developments have been positive and support an equity orientation asset allocation.
• Last week’s US Federal Reserve Fed meeting saw Powell signal that tapering of bond purchases is likely to be announced around November, with net purchases set to cease in the middle of 2022. A first interest rate hike in the US in the fourth quarter of 2022 is now in line with half of the Fed participants. US treasury bonds were initially unmoved but increased supply and a likely rate hike by the Bank of England in the 4th quarter led government bond yields higher.
• Economic data releases confirmed an expanding economy but decelerating from the prior high levels. Preliminary purchasing managers indices, a business sentiment survey, in the US showed continuing strong growth, especially in manufacturing, but modestly weaker than last month’s level. In the Euro area, both manufacturing and services preliminary purchasing managers indices are signalling strong growth, but noticeably lower than last month.
• Our asset allocation view remains overweight equity – supported by reasonable forward valuations and positive earnings growth and underweight fixed income – focusing on shorter maturities and corporate bond exposures.
• Latest US economic datapoints suggest the US consumer and manufacturing sectors are in good shape. There have been Covid related disruptions, but these should moderate similar to prior waves.
• The US Federal Reserve will meet this week. The US Federal Reserve will provide an updated economic outlook, now extending into 2024, and may announce when it will begin tapering its pandemic emergency asset purchase program (which provides liquidity and keeps interest rates lower than they might be otherwise), giving the market advance notice. The announcement on tapering could be pushed out to November, but would then remain a key risk. The pace of tapering may be indicated. Markets will focus on how quickly the Fed may expect to raise interest rates but the expectations are the members’ outlooks, not a Fed forecast and remain subject to change.
• While the peak rate of global economic growth (off of the low pandemic base) may be in the rear view mirror, and monetary policy seems set to downshift, the growth outlook remains above trend as economies are recovering from Covid and restrictive measures are gradually removed.
• Equity markets were softer whilst sovereign bond yields rose slightly last week. No specific driver for these moves, however concerns on economic growth, reduction in central bank supports, higher inflation expectations and state intervention in China were factors. Fixed income weakness likely to have been driven by significant pick up in supply in both sovereign and corporate bond markets as primary market reopened after the summer.
• The Goodbody asset allocation team met last week and decided to increase exposure to US short duration as an attractive risk return profile relative to cash. The committee also expect lower growth levels but remain positive. Global growth forecasts look to have peaked at a high level and momentum has slowed in response to delta variant and supply side shortages. Momentum and forward looking indicators have slowed recently.
• The team expects inflation pick up to be transitory. Spike in inflation due to year on year effects and supply side constraints. Labour demand continuing to outstrip supply, which should ease as economies reopen and financial supports are reduced. Inflation expectations have risen in US and in particular Europe. We expect inflation to be transitory, however, expected to settle at higher levels than seen in the past 5 years.
• Latest economic datapoints reflect a weaker growth narrative that is getting louder among financial participants. In the US, latest consumer confidence and retail sales were weak, and the latest jobs report for August indicated much lower job creation than expected in the month. In China, manufacturing and service data also came in weaker than expected. Not surprisingly, markets have responded in a defensive fashion, with cyclicals no longer outperforming defensives in recent weeks. This continued last week.
• However, a deeper look at the data tells us a different story. The August US ISM Manufacturing survey – generally a strong leading indicator - was higher than last month and beat expectations, with new orders and inventories up. And the report spoke about how supply chain bottlenecks are impacting the economy. We see these problems as transitory, not structural.
• We have already responded to the slower pace of growth by reducing our equity exposure last month, but we remain positive about continuing growth. Our recent additions in Financials and Industrials reflect this, and we are looking at Consumer as well. As the vaccination rollout continues, we think the Delta wave passes and indeed may have already peaked. Income levels still remain well above spending levels and the Central Banks are not tightening policy anytime soon.
• The first thing to understand is President Xi’s policy goal of common prosperity - he wants to reduce inequality across China. He’s also extremely concerned about the low birth rate in the country - despite reversing that one child policy in 2016, the birth rate has continued to move lower. Both of these issues are linked and they also have serious implications for the private education sector and the internet sector.
• The net effect is a less friendly investment environment - internet stocks will face increased regulation, higher costs, lower returns on invested capital and for the companies that are not focused on the areas that China views as strategically important, it means making more investment in these areas or if not, then making donations to state-backed initiatives that are focused on these areas.
• We’ll be watching the region closely but for the time-being we’re happy to stick with our position given the heightened uncertainty, regarding earnings, valuation and sentiment.
• We had tremors across equity markets as a something of a ‘growth tantrum’ hit us. The cause was Retail Sales figures missed in a few countries. Some of this would be due to consumption switching over to services and away from goods but the spreading of the Delta variant undoubtedly is having an impact as well. One important thing to bear in mind is that even though the figures may be coming in below forecast, the level is still very high. But it does show what can happen to market sentiment as we transition from the recovery phase of the cycle into the expansion phase (growth rate still above trend but decelerating). This supports what we have been doing in portfolios. Resetting the equity exposure to where we were at the start of the year, returns will be more muted going forward. But remaining overweight equities, the growth rate is still strong. Moving more into companies and sectors with more dependable growth, with less reliance on the cycle.
• What was encouraging last week was the performance of the bond markets. There was a big ramp up in discussion about tapering last week and the potential for an earlier than expected arrival of it. But bond yields declined slightly during the week. They were undoubtedly helped by the growth fears that pushed through markets but still it was a very resilient performance. For us that is encouraging. We knew that as the recovery gained traction the emergency monetary measures would have to be removed. We thought this would put fixed income markets under pressure but that they would remain orderly. This seems to be the way they are behaving.
• Developments in China grabbed a lot of attention during the week and continue to undermine Emerging Markets and Asia Pacific in particular. Month to date, MSCI Asia Pacific ex Japan is down 7% in $US terms against the world which is up slightly.
• One of the factors driving the recent growth scare was the prospect of passing the peak in growth rates. The ISM Manufacturing Index is one of the indicators that is closely followed as an indicator of the health of the US. It does appear to be peaking now. Some people would say that if the growth rate is peaking then that is bad for equity markets. We do not agree. Looking at data for the past 30 years, the equity market has continued to move ahead in periods following an ISM peak. More specifically, if we look at periods when the ISM has recovered from below 50 and then peaks but still remains above 50 (i.e. the economy remains in expansion) the S&P 500 was up in all them. The average return in these ‘past the peak but still in recovery’ phases was over 30% (worth pointing out the average period here lasted 3 years). So the peaking is not the important thing – it is whether we remain in expansion after. Consensus forecasts indicate that not only will we be in expansion mode it will be well above trend.
• An interesting feature of the recent turnaround was the source of flows on the recovery day. Retail investors accounted for nearly 90% of activity on the New York stock exchange on Tuesday. This is the second time in less than two months that a very weak down in the US market has sparked retail buying. We had been wary of the argument that post a strong start to the year there was potential for a correction along the way. We acknowledged that this could happen but felt that it was unlikely to be large enough to be able to add any value positioning for it. The performance around the two recent scares re-enforces that. The ‘buy the dip’ mentality is strong and it has fire power.
• The result season has got off to a very strong start. It looks like it will be close to a record season again. The standout so far has been the changes to guidance. Close to 90% of companies that have reported so far have improved their outlook. There was a chance that we could have good second quarter results but that companies could make cautious outlook statements due to rising input costs or supply chain issues. This not turning out to be the case and earnings should provide strong support for further advances in equity markets.
• There was another big CPI figure in the US accelerating on a MoM and YoY basis but curiously the bond market barely fluttered. But as we were saying last week the growth outlook was capturing more attention than the inflation outlook.
• Could it turn grim? We expect the economic momentum to fade but remain well above trend. Last week we did see some glimpses to support that. Firstly China, leading the global recovery and leading the fade. In the Q2 GDP report, released last week, annualised growth was 7.9%, below the 8.5% forecast for the year but the June releases in it (Retail Sales and Industrial Production) showed strong rebounds. The growth rate may be fading but stabilising at a relatively high rate.
• Pulling all this together we have elevated inflation which still looks like it will subside and anyway central banks do not seem alarmed by it. Hence although we would expect yields to rise in the fixed income markets, they are likely to remain orderly. There are a lot of signs of slowing momentum in the global economy, but the growth rate remains high which will continue to drive strong earnings growth and thus the environment remains equity friendly and it remains the asset class of choice.
• The market has moved rapidly from worrying about an overheating global economy sparking off an inflation spiral to a peak in economic momentum starting off a significant slowdown, with 10-year yields in the US dropping below 1.3%. We agree that economic (and earnings) momentum will start to decline (i.e. the rate of increase will start to subside), but growth will still be well above trend.
• Unusual for this stage of the cycle, it is going to get further fiscal support from the Recovery Plan in the euro area and the potential for an infrastructure bill in the US.
• There was nothing through the week suggesting we should alter our course. Growth fears are over-done, if that is what is driving bond yields down. We must remember that bond markets are somewhat distorted by the large presence of central banks and negative interest rates across many parts of the globe. The change in Chinese policy reminds us that authorities everywhere are very mindful of not letting economies slip backwards especially with the Delta variant spreading. We have been positioning for a fading in growth rates but still an above trend growth rate along with the withdrawal of the emergency elements of monetary policy. Nothing has happened to change that position.
• After a brief panic, equity markets resumed their upward march buoyed by more reassuring comments from FOMC members including Chair Powell reiterating that much of the inflation pressure stills appears transient and that the Fed will be patient.
• The economic data gave a little bit of relief on inflation. In the US, the PCE (Personal Consumption Expenditures) pricing data, the measure which the Fed watches, came in below expectations, above 3% on a YoY basis but down on a MoM basis, 0.7% to 0.4%.
• It appears that there have been some very positive developments on the potential for a large sized infrastructure package in the US. It looked like it was going to get bogged down in arguments over social infrastructure and the climate change agenda. This could re-emerge, but it is looking good for continuing fiscal support for the US economy beyond 2022.
• After the calmness of recent times, last week ended poorly. Inflation concerns and the speeding up of the rate cycle following the Fed meeting on Wednesday was the central catalyst.
• The Fed meeting put markets into defensive mode as bond markets advanced. In our view, the output from the Fed does not change the roadmap very much.
• The main take away for us is that we are moving out of the recovery phase of the cycle. Monetary policy remains supportive but the extreme elements of it are being withdrawn. What does this mean for asset allocation? Generally, equity markets continue to make progress and are the asset of choice as we move through this transition but, unsurprisingly, the rate of return is lower.
• The bond market is somewhat confusing. In past cycles the yield would have been rising as we travelled towards the change in monetary gears, as we had up to March. The recent strength is baffling but from our perspective somewhat helpful. We still expect yields to track higher, but an important part of our outlook was that the rise in yields would be orderly. The recent action in the bond markets gives us comfort on this
• Equity and fixed income markets were better over the week despite a strong CPI figure from the US. The reaction from the bond markets is the most surprising. Not only have we not seen them sell off they have actually strengthened as we saw data releases in the US that would put you on guard about increased inflationary pressure.
• The ECB held its Council meeting last week and as expected, it will continue with elevated buying for the next three months but no guidance as to what happens then. ECB President Lagarde reiterated that it is too early to debate end of PEPP and reiterated the importance of keeping policy support in place while the economy recovers.
• The US is recovering despite supply issues, some of which we expect to be temporary but others might be stickier and so we are watching closely.
• Recently we have seen a switch back to mid-cycle trends, a bit of life in the Healthcare and IT sectors, and a resurgence in belief in the re-opening theme.
• We think we are going to see the maximum momentum in the global economy over the next couple of months. The euro area re-opening will be at its strongest and the US has the potential to improve from the mixed range of data over the last month. But both are likely to peak out in July. We are already seeing the other major block China begin to level off.
• Secondly the price moves could indicate a ‘changing of gears’ in the market. We are still seeing strong economic and earnings news, the revision ratio is at the highest level ever recorded and there are still upward revisions to economic growth forecasts. But the market reaction is far more muted, world equities are up just over 1% in US dollar terms in the last month against 11% YTD. Sector leadership has also been shifting around between Cyclicals, Defensives and Quality. There are all signs that the market may be moving to anticipate the peak of growth momentum.
• Thirdly, we are looking to adjust our equity exposure tilting it towards sectors, industries and themes that can do well in a mid-cycle. Within Technology, the Internet theme is well-placed as it’s growth rate will become increasingly attractive supported by both cyclical and structural drivers.
• Last week’s muted asset market moves cover some interesting developments below the surface. As we all know inflation has been a topic on everybody’s mind of late, but the concerns seem be under control. Bond yields have moved up but not in a very meaningful way. The yield has not got back to the highs we have seen earlier this year. In equity markets the defensive sectors and quality have been relative winners recently, not what you would expect in an inflationary environment.
• We have seen some levelling off in the economic data from the US which is pulling some momentum out of the global figures. However, last week’s PMI’s from the euro area suggests the reopening is leading to a stronger recovery than expected and this should offset the lower momentum from the US.
• So, for the short term it will still feel like the recovery phase of the cycle. But we are approaching the end of this and markets will start to discount this inevitable momentum lull.
• Inflation is the main talking point at the moment with the surprise in the US CPI figure. We are lapping the weakest point for prices in 2020 so, as we have been saying all along, there was always going to be a spike in inflation figures. We believe it will be transient and that inflation will fall back as demand growth normalises and the structural forces come back to play. We are still in that camp.
• The discussion about whether the spike in inflation is transient or not will continue and we will be monitoring the data but it is reassuring that most of the inflation is coming from the reopening categories and some quirky developments It has been a strange recession and recovery and continues to be so. Of the 0.9% increase mom 0.38% came from 2nd hand car and truck prices because supply of new vehicles is limited due the semi-conductor shortage. Lodging & transport added another 0.2% reflecting the opening in air travel and hotel industries.
• The inflation releases do not change our investment strategy. We have been positioned for an economic recovery that would entail higher inflation. Equites provide us with a form of inflation hedge. Higher inflation generally means higher sales growth so equity markets can handle some rise in bond yields due to the rising inflation.
• The big miss in the non-farm payrolls does give some food for thought. One cannot read too much into one figure, but it does affect timelines. We were expecting a peak in economic momentum by June. Asia has already rolled over, the US would be starting to in May / June which would leave only Europe showing stronger momentum. Consequently, we would see the growth in global activity begin to fade from June. It could also allow the Fed to start talking about tapering. This all looks like it is going to be pushed out by a month at least.
• For equity markets this is probably a reasonable outcome. The possibility of the Fed talking about tapering has been weighing on sentiment. This weak jobs figure combined with the large downward revision to the previous month means this could be put off for up to three months. For US bonds it is probably a modest positive as well, at least on a relative basis. One of the factors driving up the spread on US fixed income assets anyway was a much earlier moves from the Fed versus other Central Banks. That time gap is looking shorter now making US fixed that little bit more attractive on a relative basis, so it is worth revisiting the switch from euro area fixed income into US fixed income.
• In equity markets we have been looking at reducing early recovery exposure and transition towards more mid-cycle exposure. We are likely to be doing more of that this quarter, but it does not look as urgent as it did last week.
• Policy risks featured last week with the dreaded words of taxation and tapering both hitting the headlines. In the US we got further details on Biden’s infrastructure plan which will entail some taxation funding. There is still a long process to get these proposals approved so the end result could be quite different. In the meantime earnings are moving far faster in this cycle so that any higher level of corporate taxation could be more than compensated for.
• Last week saw the first of the major central banks move to tapering. The Bank of Canada will be reducing its level of bond buying going forward. This caused some broader concern, but there are some features unique to Canada that suggest read-through to other economies and central banks is limited.
• The economic data for the next couple of months will probably continue to run hot. PMI’s from the euro area were better than expected. The strong recovery is still driving earnings upwards. Less than 20% of companies have reported in the US but earnings are coming in more than 20% better than expected. It is heavily influenced by the volatile financial sector, but it is still a very large figure especially given that forecasts have already been raised and we are several quarters into the recovery. With reopening only starting profits will get another boost. So just like the economies, profit progression is going to look early recovery as well over the next couple of months.
• Overall, the data coming out over the last week confirms that we are still experiencing a strong recovery and that looks like it will hold into the middle of the year at least. Stability has also returned to the bond market. We believed that yields would rise in 2021 but that it would be orderly, and it would be driven by better growth prospects. This has turned out much better than we expected.
• The last few weeks have given some clues of what the world could be like as Western economies move towards re-opening. In the US we had the strong payrolls data a few weeks ago and last week we had the ballistic Retail Sales figure, almost 10% growth at the headline level. The US is going to take the lead in the global economy in the second quarter. Meantime the old leader, China, sees some levelling off. The actual growth figures are still large but not any bigger than expected. The US will still look like it is in the early stages of recovery and China looks like it might be moving into the mature stages of its recovery.
• Another feature that was apparent in the recent data is the leadership of the Consumer and Consumer Services in particular. We believe this theme will gather further momentum in the next few months.
• Probably the most pleasing aspect of the last week was the drop in bond yields led by falls in the US. This is despite the very strong economic data we have been getting. We do expect higher bond yields in 2021 but with the central banks in the background we always believed this would be a limited and orderly rise. Developments over the last week give support to that view. A calmer bond market along with strong earnings and economic data will give good support to equity markets.
• The Q1 reporting season is underway and it is off to a strong start. This is pleasing as the first week is normally the toughest. For the first quarter, EPS is expected to rise 27% for the S&P500 and almost 38% in the euro area. This will be a unique reporting season as forecasts have been increased going into it – usually analysts are revising down their forecasts at this stage.
• This year has started just as last year ended, with strong momentum in equity markets. In the first quarter, global equities delivered a total return of just over 9% in euro terms, a little over 6% in local currency terms. The strength of the global economy, earnings, roll out of vaccinations and further fiscal support were the principal drivers.
• It was a troubled quarter for fixed income markets, in particular sovereign debt. Euro area corporate credit did perform better with a return of -0.6% against the broad bond market return of -1.9%. The low starting yield, larger stimulus plans and inflation concerns undermined the bond markets but the price action was quite orderly. But central banks do not share the bond markets concerns. From the Fed minutes released last week the members are making it clear that the Fed is going to be re-active rather than pre-emptive.
• The second quarter is unlikely to be as strong as the first – there is likely to be a bit of ‘travel and arrival’ as we see the impact of reopening – but profit growth is turning out to be very strong, bringing multiples down very quickly and hence we still favour equity markets. Moves in bond yields have been quite orderly and as a result the benefit of the higher economic growth more than offsets the valuation impact of higher bond yields.
• A relatively quiet week with the equity market under a bit of pressure most of the week until a late rally on Friday turned it into an up week overall.
• Quarter end fund rebalancing was in focus. As the equity market has outperformed the bond market by so much in quarter the ratio of equities to bonds within these funds would have fallen out of line and thus equities would need to be sold and bonds bought. Typically a lot of these funds target a 60-40 split equity to bonds. There were mixed reports on the quantum of this in the equity market with reports of up to US$150bn dollars to be sold. There were other reports that a lot of this was executed during the week last week and this would possibly explain the positive reversal in the markets on Friday.
• Emerging markets have tended to outperform in cyclical recoveries. We expect this phase of the economic cycle to better suit emerging markets – unlike the last cycle, which was characterised by a decelerating China and low nominal growth rates. International tensions that rose during the Trump presidency are likely to moderate under President Biden. Relative valuations seem reasonable – emerging markets are cheaper than developed and their long term average. Earnings momentum is improving. The pull-back from recent highs provides a potentially attractive entry point.
• Markets are balancing optimism for strong economic growth on reopening and recovery from the pandemic against a more accommodative US Federal Reserve and rising bond yields. There is some near-term concern about renewed/extended lockdowns, particularly in Europe, but this seems more of a timing issue than trend. Early indications of consumer services demand are positive in regions further advanced in reopening.
• The Federal Reserve’s FOMC meeting last week highlighted the new flexible average inflation targeting regime means the Fed will be waiting to see actual data rather than forecasts before making policy moves.
•With better growth forecasts behind bond yields moving up, we expect equity markets will continue to trend higher. More economically sensitive equity sectors and regions have been responding to the better growth forecasts and reopening, while higher valued sectors, e.g. IT have underperformed due to rising bond yields. The gear shifting within markets is likely to continue, albeit at a slower pace as the recovery advances. Overall valuation multiples are more likely to contract than expand, but strong earnings growth should drive equity returns.
• The tussle in the fixed income markets continued last week, but it remains orderly. There were bond auctions in the US which probably added some pressure. We are getting the same picture painted by events last week. We have a stronger global economy that is raising inflation concerns but central banks remain passive feeling these inflationary pressures are transitory. Nothing has come along to change the longer-term view of inflation.
• The policy background remains constant. The outcome of the ECB Council Meeting was benign. It sees no change to the medium-term outlook for any inflation and it will look through any acceleration that may happen in 2021.
• We have used the turbulence in the bond markets to alter our mix. The focus has been on the geographic mix rather than sectoral. The US Euro spread has been steadily widening and is now attractive enough to switch some exposure. It is providing an opportunity for us to give our clients a positive return on some of their safe haven assets. If it widens further, we will do more.
• In the equity mix we are looking at the nature of our cyclical exposure, not the level of it, just how early cycle do want to be. We are one year into the recovery now.
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Last week the US fixed income markets felt pressure with rising bond yields, drivers being the Fed and the market participants. We also saw non-farm payroll numbers released, showing an increase in numbers in employment in sectors most effected by COVID 19 such as hospitality, travel and leisure.
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Goodbody is expecting an increase in inflation, delivering profit growth with central banks remaining relatively accommodative.
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Small changes expected in fixed income market moving some exposure over to the US. Looking at the Equity market, at the structural growth sectors and exploring new opportunities as turmoil in the bond markets is expected to pass.
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Turbulent week in the fixed income markets last week with bond yields climbing up as US investors feel the pressure of the scale of the US fiscal package. We have also seen the Fed and central banks not changing policy and maintaining the same level until year end. ECB council members weighed in on accelerating their QE purchases, which resulted in panic in the fixed income markets.
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The equity markets felt pressure due to higher bond yields, with investors switching to cyclical growth sectors such as industrials, chemicals and commodities. However, with stability in the bond markets, we will see some of these trends reversing.
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In relation to client portfolios we are focusing on the fixed income market, as we have seen bond yields rise in the US, and the spread between US yields and Euro area yields widening out.
• The larger stimulus in the US and thoughts of a recovery package after that is giving the fixed income market something to think about. It is an adjustment we knew we had to go through and so far, it is occurring in a manageable way.
• The earnings recession is over in the US. The S&P 500 is now recording 6% annual earnings growth. Strip out the challenged industries and you get 12% earnings growth. This is a quicker turn around than even we expected at the start of the year. Each unit of economic growth is generating a higher level of profit growth than we are used to.
• In the meantime the growth outlook is still improving. Management of the pandemic is improving, shortening the timeline for re-opening. The Retail Sales figure in the US was very strong indicating the economy is traveling through the lockdown disruption much better than was feared. It gives a strong base for the rest of the year. We believed we would see further upgrades to global growth and this leaves us more comfortable with that assumption.
• The recovery continues as equity markets push on towards new highs. Further progress on the next round of stimulus in the US, improving data on Covid 19 infections and build up in vaccination rates are giving greater confidence in the global economic recovery.
• Earnings delivery is very strong. In the US earnings are up 2% YoY against an 11% drop expected. If we exclude the very troubled sectors: Energy; Transport; Industrials (read aerospace) and Consumer Services, earnings are up 11% YoY and that is off a normal quarter, not a recessionary one.
• Policy developments remain positive. We are on track for the next fiscal package in the US and talks are starting for the recovery plan.
• Fixed income markets remain under contained pressure. The US is weakest, not surprising given all the extra spending and the greatest potential to deliver an inflation surprise. However, we still seem to be going through the deflationary effects of the pandemic so it could be some time before we see inflation pressures rise.
• Investors’ doubts disappeared quickly last week and equity markets have gone back towards the highs of January. The re-opening theme is back in vogue and has further to go but prices are moving quickly. Policy developments, falling Covid19 cases and increasing momentum in vaccinations were the main drivers.
• US fiscal policy is getting ever more expansive. We got a fiscal package earlier than expected in December and now looks like we will be getting another towards the top end of the range by March / April time as the Democrats decide to go it alone. This is key for the re-opening theme as much of the spending is geared towards plugging holes in the economy due to shutdowns rather than any new growth plan.
• The earnings season remains extremely positive. In the US earnings are now up 6% YoY and seven of the eleven sectors are delivering double digit earnings growth. With further stimulus to come the forecasts are likely like to rise further.
• Short term jitters carried onto month end. Neither the bond market nor the US dollar are seeing major flows. We would regard current weakness as a phase of consolidation. We expected short term bumps but the longer-term case is intact.
• The policy support continues to improve. Another fiscal package is on the way in the US and may end up at the higher end of expectations. This should help us get through what is likely to be a more difficult start to the year due to the wider and deeper lock downs. The Fed also re-iterated its easy stance which is a powerful combination for risk assets.
• The earnings season is going extremely well. A good season was expected but there are some features which are worth recapping on. Going into this reporting season forecasts were increased. This is very unusual, normally forecasts are reduced, but this time the bar has been raised and this is being beaten. Eight out of eleven sectors are now seeing YoY earnings increases. For the market as a whole, sales are now up YoY.
• There is a lot of worry out there about new variants and high hospitalisations leading to increased travel restrictions being implemented and general lockdown extensions. At the same time as renewed lockdown worries, case growth is falling and vaccination rates are accelerating.
• Market fundamentals also continue to improve despite near term hurdles. Economic forecasts are moving up with the greatest strength coming from the US. We believe there is further to go especially if the current negotiations over another fiscal package in the US lead to further stimulus.
• But none of this increased activity has led to any significant movement in inflation forecasts. In fact, the only change we have seen is a cut to inflation expectations in China, the first economy to get back on track. One would expect some inflation but acting against it are the deflationary shock of the Covid19 pandemic, spare capacity in the global economy and the ongoing disruption across all industries.
• We are in a bit of a lull as the market awaits the full results season and how Covid 19 will play out over the next few weeks.
• We are still getting signs of a disrupted economy in the short term as consumer health driven caution and lockdowns continue to impact on the global economy.
• Positively, we continue to get the policy offset. President elect Biden’s stimulus plan gives further confidence to this so despite the current economic weakness, we still expect the global economy to have a stronger year than is currently forecast and this underpins our positive view on equities.
• Equity markets have started the year strongly. We thought that there was upside to the economic and earnings growth forecasts for 2021 and that is looking more likely now despite the short-term disruptions. We remain committed to our bullish call on equities.
• The US non-farm payroll number indicates the scale of economic disruption we could have in the very short-term. The weakness came in all the Covid related sectors and we are likely to see more of this as we travel through January. However, on the other side we have the roll out of vaccination which should gather momentum and the ‘light blue sweep’ in the US. Although numbers in the Senate are tight, if further fiscal action is needed it should now occur quite quickly – this is different to Autumn 2020.
• In addition, the Fed also remains firmly supportive. Musings by some Fed members that tapering could occur a bit earlier than thought were dismissed quite emphatically by vice chairman Clarida. His belief is there will be no change this year. The Fed will be waiting to see if policy have any sustained impact on inflation rather than theorising about what the potential impact will be.
• Firstly, Bernard highlights that we had agreement to a fiscal stimulus package in the US. Some details are still being argued over, but it is an important measure to get passed.
• Secondly, there is a Brexit deal in place. Here also there are details to be worked out but we have avoided a messy situation and that is a positive.
• Taken together, these are supportive of growth and markets in the year ahead amidst short term volatility with this latest COVID surge which will undoubtedly cause some market turbulence in the early part of 2021.
• We are expecting an accelerating economic rebound through 2021 and ongoing expansion in the years to follow.
• Bernard highlighted that there may be bumps along the way but the inflation backdrop will remain subdued and central banks are poised to remain easy even as the recovery accelerates. Accordingly, conditions are in place for further sustained equity market gain.s
• The Goodbody Investment team favour risk assets in this environment. The team is increasing the equity exposure of the multi-asset models, with a greater cyclical bias in those additions.
• The team would still be cautious about deep cyclicals as these generally need inflation (and higher interest rates for banks) and despite a potentially good recovery in 2021, we are still in a low trend growth world.
• Election result with no blue wave is a good outcome in our view. As per our client conference call last week, we believe a divided Congress will mean less extreme policy outcomes, which is a directly supportive factor for the market. In particular, significant corporate and income tax increases now appear to be unlikely.
• Goodbody Investment Team will be investing what cash levels there are in models in equity, with the increased allocations biased to structural growth and regionally we favour adding to Asia in particular. Industrials reflect tentative re-opening optimism and are also favoured, in line with our cautiously optimistic growth view.
• Market were impacted last week by the rise in COVID-19 cases and hospitalisations across Europe, as Pfizer also announced delays on their vaccine research data.
• Q3 earnings results trends have been encouraging - in the US, the results are coming in at 19% ahead of expectations, with similar trends for Europe albeit fewer reporting companies.
• US election polls are indicating a democratic sweep which would be a positive outcome for financial markets but concerns linger about the potential for a Democrat in the White House and a split congress which would delay and impact the size of the fiscal package.
• After a choppy period, markets were flat last week as Brexit negotiations see-saw and lockdowns in Europe become commonplace.
• However, encouraging data came out of China and Q3 earnings season kicked off last week with many US banks reporting encouraging trends
• The rate of COVID 19 infections is on the rise again in Europe, impacting sentiment but there is cautious optimism on hopes of a vaccine from companies such as Pfizer and AstraZeneca
• Niamh discussed reasons for the stronger market performance in China, US and euro area over recent days
• She also focussed on the implications for markets of a democratic sweep in the upcoming US elections
• Markets are performing better than expected in the wake of rising infections across the globe and delayed news on the vaccine.
• In the United States, progress on the fiscal stimulus package has been positive. However, the country is grappling with the positive coronavirus diagnosis of President Trump in the lead up to a pivotal election which will be discussed in a Goodbody webinar tomorrow.
• In the short-term, the lack of fiscal stimulus in the US is weighing on markets as the Democrats and Republicans remain deadlocked over a package in the wake of the upcoming election.
• A pickup in COVID-19 cases globally continues to be another important market driver.
• Bernard discusses market developments and relevant economic data points over the past week
• In tandem to lockdown concerns, Bernard emphasises the importance of confirmation of supportive measures to quell recessionary fears
• Bernard makes the case for and against increases in inflation