The global economy is expected to rebound strongly in 2021 by 5.5% according to the IMF as vaccination programmes with continuing financial support from governments around the world bring an end to the coronavirus pandemic. Accordingly, the year started brightly continuing the market growth of the second half of 2020. Indeed, the US equity market has registered its strongest 12-months since 1936.
Economic Recovery and Inflation Jitters
However, volatility returned in mid-February as investors assessed the potential inflationary impact of the enormous economic stimulus (estimated at $20tn by JP Morgan), the route map out of the pandemic in different countries and stretched valuations in certain sectors. Most notably, President Biden’s $1.9tn stimulus package and promise to offer Americans a vaccination by 1 May alerted investors to the prospect that the US economy could recover more quickly than previously anticipated with the aim of getting back closer to normal by 4 July, Independence Day. The speed of the vaccination programme in the US may also be accelerated by the licensing of single-dose vaccines, such as Johnson & Johnson.
In addition, US Treasury Secretary, Janet Yellen pledging to ‘act big’ on the economic recovery and dovish comments by US Federal Reserve Chairman, Jerome Powell fuelled concerns that inflation in excess of the 2% target may result. However, Mr Powell indicated that any inflation from the economic recovery is likely to be transitory, so he does not see any need to increase interest rates or alter the bond buying (QE) programme at this stage.
Bond Market Tantrum as Yields Spike
Nevertheless, despite short-term interest rates remaining anchored to the floor, bond yields have surged with the 10-year US Treasury Bond rising from around 0.9% at the start of the year to above 1.6% by the end of March. Since bond prices fall if yields rise, this development has been most unwelcome for bond investors, although in reality this move reflects the optimism of an economic recovery and does not herald 1970s-style high inflation, which was a consequence of new welfare states, enormous rebuilding after the second world war, a global oil crisis and strong trade unions. At present, there is little wage growth to support the fear of much higher inflation.
Equities Reflect Wider Economic Recovery
In terms of equity markets, overall they moved higher in the first quarter. The US market continued to outperform global equities and the UK market registered a strong performance benefiting from the focus of the FTSE-100 on traditional sectors, a well organised vaccination roll-out and certainty on the future relationship with the EU. Weaker markets included emerging and Asian markets as the US dollar has rallied on the expectation of a quicker US recovery. Continental European markets have been held back as the third wave of coronavirus and a botched EU vaccination programme have delayed the re-opening of economies.
Technology Stocks Take a Back Seat
Technology stocks struggled as prices depend on valuations placed on the growth of future earnings. When interest rates and inflation are low, as they are now, the present value of future earnings is higher than if interest rates may be higher in future which requires a discount to be applied. In addition to this technical valuation point, some technology stocks performed very strongly during the lockdown periods, which resulted in some profit-taking in February and a rotation into more economically sensitive sectors with the potential to perform with the re-opening of the global economy.
Market Rotation to Value
As such, over the last 3-months, the performance of equities has polarised as technology and ‘growth’ sectors have struggled to make progress, whilst after years in the doldrums ‘value’ stocks have rallied strongly, notably financials, industrials, energy and mining. These sectors tend to do better as inflation and interest rates tick upwards, provided of course inflation is kept under control and economic growth is maintained. In some cases, there has also been a ‘dash for trash’ as investors have chased stocks with valuations battered from the economic effect of covid-19.
Markets Remain Resilient
Equity markets have in many ways proven resilient as unforeseen events have had minimal impact taking a longer term wider view. Notably, the blockage of the Suez Canal by the Ever Given, one of world’s busiest shipping routes showed the fragility of global trade supply lines in March. In February, amateur investors took on professional traders by speculating with GameStop and similar stocks reviving memories of the dot.com bubble of the late 1990s. More recently, the failure of Greensill and Archegos Capital, which is likely to hit Credit Suisse and Nomura particularly hard, have acted as a timely reminder of the importance of adequate risk controls and managing leverage in financial institutions.
Economic Recovery Anticipated
In simple terms, the economic recovery is dependent on the pandemic being brought under control globally in 2021. This means, the markets continue to look to economic recovery for the remainder of 2021 as the global economy re-opens. Accordingly, as the pent-up consumer demand is released there should be a significant increase in economic activity benefiting companies and investors alike.
US Stimulus Measures Accelerate Recovery
In the US, President Biden is now focused on delivering a $2tn Infrastructure Plan, which would be an unprecedented level of investment covering a broad range of both social and economic projects in the US. This is in addition to the recent $1.9tn coronavirus relief package. Such government support should give the US economy a powerful fillip to accelerate the economic recovery, estimated at 6.5% for 2021.
Technology will Continue to Drive Growth
Whilst markets have stumbled in the last couple of months fretting about inflation, this is likely to be short-lived as a resumption of more normal pedestrian growth levels resume in 2022. The transformation of every area of our lives by technology will continue, whether the drive for clean energy, protecting the climate, digital innovation or medical science; as such, companies delivering higher levels of growth will continue to command a premium, particularly when growth becomes more scarce as taxes begin to rise in 2023. Analysts are forecasting strong growth in earnings from technology companies over the next two years.
Balancing Coronavirus Control with Economic Impact
In the short-term, the main concern remains the third and fourth waves of coronavirus in the EU and Japan and the efficacy of the global vaccination programmes as well as the risk of virus mutations, so as to permit the re-opening of the global economy and the Olympic games. There is also the ongoing balancing act of central banks and governments modulating stimulus measures so the private sector can pick up the baton, whilst preventing an overheating as demand returns.
Looking further ahead, there is the big issue of how the pandemic will be paid for with higher taxes and concerns about high levels of debt impacting on future growth. But, the outlook for now is positive as optimism about the recovery dominates the agenda.
Please note, our Market Overview & Outlook is our view of markets and does not constitute investment advice. Past performance is not necessarily an indication of future returns; the value of investments and any income from them is not guaranteed and can fall as well as rise. Overseas investments are affected by currency movements and exchange rates. If you would like investment advice on your individual circumstances, please do not hesitate to get in touch, telephone 01392 875500, info@SeabrookClark.co.uk