April was another positive month for global markets. Equity markets returned a positive performance, with decent economic data, higher-than-expected corporate earnings and increased market optimism. Developed markets benefited most from the reopening of economies while emerging markets continued to normalise. Commodities returned a strong performance, with the global economic rebound increasing pressure on limited offer vs growing demand. Despite higher inflation readings, central banks remained dovish but their future communication will be key to market evolution.
The moment of truth
Financial markets have shown a lack of leadership since the beginning of April. Macro indicators have been going sideways, with a well-below-expectations NFP (+266 vs +1M expected) counterbalanced by US and Eurozone Manufacturing PMIs remaining close to historically high levels (respectively 60.5 and 62.9). On the sanitary side, worries resurfaced, with a new COVID wave deeply impacting India and Brazil and showing that the pandemic was not over.
In developed economies, the vaccination rollout continued, with some countries moving closer to immunity (US and UK). In this context, economies have started to reopen gradually and sequentially.
The Q1 earnings season showed very strong EPS positive surprises in all regions (85% positive surprises for the S&P 500 / 71% for the Stoxx 600 Europe), with cyclicals, at the forefront, helping the equity rotation towards cyclicals and value to proceed.
China’s economy remained robust and US GDP is expected to grow at a 6.5% pace in 2021 – closing the 2020 scar. The Eurozone should follow the trend very soon by closing the vaccination gap this summer.
In this context, rapid reopening economies and low inventories have created bottlenecks in many supply chains, ranging from commodity prices (copper surging to an all-time high) to semiconductors, with lead time surging in every product segment (22 weeks / 5-year high for sensors). Higher input prices have pushed inflation expectations to the upside (5Y US breakeven trending up by more than 20 bps since early April, to 2.79), questioning how central banks will react. Given disappointing figures on the labour market and the fact that central banks expect inflation to be transitory, markets have anticipated the FED delaying the tapering process, keeping US nominal yields flat, at 1.60, and pushing real rates lower, to -0.91% (-28 bps since beginning of April).
Next move on the markets to be determined by the direction of rates and FED reaction to inflation
The Fed continues to communicate out loud that it will be more tolerant of inflation and put its focus on employment. To this end, full inclusive employment may take years (if ever) to materialise. However, as inflation lingers, this is something the FED will still have to watch like a hawk. Indeed, it cannot risk reacting to a rapid rise in inflation expectations and allowing the market to test its limits. Central bank credibility is essential to anchor inflation expectations and avoid any future rate slippage. The announcement of a tapering will therefore be the next game-changer on the markets and, likely to be no good news for the most stretched valuations in the market, will reinforce our current tilt towards value equities in our portfolios.
In this context of a sustainable growth regime, with reaffirmed central bank support and yields to the upside, rotation should continue. If history is any guide, this phase usually also coincides with a better performance of the stock markets outside the US, due to their cyclical or value characteristics. In this regard, Europe should be an outperformer in the coming months, as its economy will be the very next one to reopen.
Risks to the scenario
Clearly, some risks remain. Vaccines could be less efficient against possible new variants. For the time being, it does not seem the case. However, some emerging countries are suffering from the lack of vaccines, which will result possibly in less openness of the economies around the world. Willingness to be vaccinated could also be a risk, as we see vaccination slowing in the US due to vaccine hesitancy. Failure to meet the immunity target could then pave the way to new unexpected COVID waves and new lockdowns, impacting negatively the recovery. Another risk could see an uncontrolled, overly fast, for example, rise in bond yields. The next inflation figures in the US over Q2 should be high, due partly to basis effects. That could put investors’ nerves on edge and induce an equity correction. Geopolitical tensions may arise with China and Russia. The new US administration seems to prefer a more subtle approach than the last one, but one that will perhaps be harder over the long term.
Our current multi-asset strategy
We remain positive equity vs. bonds and, in our equity allocation, are keeping our strategy geared towards reflation trades that reflect the latest positive evolution in the economy. That includes being overweight European and Japanese equities, with a preference for small and mid-caps, an overweight in emerging equities and an increasing interest in Latin America (a laggard in the aftermath of the peak of the crisis), and overweights in US small and mid-caps and global banks (a sector that usually benefits from the increase in rates).
On the fixed-income side, we remain underweight government bonds. We also remain long commodities, which should still benefit from the catch-up in demand.