In June, economic indicators showed that growth remained sound across the world, notably in the service sector. Indeed, even if the pandemic continues to affect some emerging countries, the vaccination campaigns in the developed countries, notably those in Europe, have alleviated many restrictions. However, supply-side constraints, due to the strength of the rebound and the specificity of the crisis, continue to weigh on the economy. On the one hand, labour market indicators are difficult to read and may complicate investors’ interpretation of growth. On the other, inflation may stay higher for longer. This has driven the FED to surprise investors by moving its dots, showing its ability to fight the phenomenon. The other main central banks, the ECB and the BOJ, have not changed their minds, encouraging belief in the continuation of monetary support in these zones.
Uncertainties growing
PMI indicators are showing some divergence around the world. China, the first country to be affected by the crisis and the first to take strong economic measures to limit the pandemic, has already begun to limit support to the economy. The credit impulse, which measures the economy, is now back to its lows. This could influence the rest of world over the coming months.
In the US, the levels reached by economic surveys such as the ISM have proven unsustainable. In Europe, even if these surveys remain well oriented, investors seem to have successfully integrated the impact of the rebound.
Inflation remains very high. The FED showed that it would not stay “behind the curve”, allowing some respite to break-even yields, and reassuring investors, notably foreign ones, who profited from the relatively high US long-term yield levels to buy US bonds. The impact was quite apparent on the equity-rotation theme, which helped growth stocks such as tech companies outperform the “value” sector. The US equity market, more “growth”-oriented, therefore performed quite well. The emerging markets showed major divergences. Some indices, e.g., Korea, Taiwan, continued to climb, due to their tech ponderation. Others, like the Chinese stock market, were durably affected by government macroeconomic measures, more specifically those affecting tech companies. Latin American markets, influenced by a belief in a future reopening and by less monetary support, were more stable.
The PBoC should keep financial conditions stable and could implement easing measures soon.
Our credo
Valuations of risky assets are now much more stretched, leaving them more sensitive to external shocks such as more active variants. The move on long-term rates was very fast between September 2020 and April 2021. Rates took a break, with decelerating Q2 growth in the US and China, before picking up again in succeeding months. Consequently, we believe that these two events could eventually harm value stocks, notably European stocks, which are more factor-orientated.
From a longer-term perspective, we remain convinced that growth will remain sound over the next few years. Even if the economy proves unable to sustain the pace of recent months, there should be fiscal support, notably in Europe, due to the NGEU plan. Societal changes, green and equitable, will have a durable impact on markets, moving investors’ choices and companies’ margins, depending on their abilities to adjust. Monetary support should be reduced over time, but very slowly, by the main central banks and should drive real yields quietly higher and help “value” stocks to perform.
Risks to the scenario
The diffusion of the variants needs to be closely watched. Even if the vaccines seemed to be efficient versus the current variants, any diffusion could affect the reopening or at least the nature of growth over the next few months. This would push long-term yields lower. Another risk is that supply-side constraints could last longer than anticipated. This would mean more durable inflation and a squeeze on companies’ margins. Investors could be less confident in a “goldilocks” scenario of transitory inflation and solid & durable growth.
Our current multi-asset strategy
This transitory phase could mean more volatility for risky assets before a continuation of the reflationary environment is opted for. Moreover, market liquidity is, as a rule, poor during the summer season, and this could exacerbate volatility. We are therefore hedging our global equity portfolio risk by buying some protection on European equities to be neutral equities vs. bonds. On the fixed-income side, we remain underweight government bonds, due to current low-yield levels.
However, from a longer-term approach perspective, we continue to believe in a broad recovery, i.e., in higher inflation and higher yields, which should benefit the “value” sector. In such an environment, we remain positive on commodities and emerging markets, notably LatAm stocks.
The table below indicates the major exposures and movements within a balanced diversified model portfolio.
