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I hope you and your loved ones have been enjoying the fine weather we have been experiencing over the last few weeks as we move into Summer. Many will be watching the Government’s travel advice closely and trying to decide whether to risk a holiday abroad or play it safe with a staycation.
Markets, similarly, appear to be in wait and see mode. All eyes are, as they have been for a while, on the US labour market, inflation numbers and resultant moves in the Government Bond markets.
After the steep rise in government bond yields at the beginning of the year, yields have been broadly flat over the last few months, allowing equity markets to make incremental progress, albeit with few discernible drivers from day to day:
As I have discussed before, the current environment is more uncertain than it was a year ago. The constant discussion around the future of inflation, heightened asset prices (almost everywhere), so called “meme stocks” and cryptocurrency volatility, to name a few, makes investors’ lives that much more difficult.
This uncertainty has led investors to the relative safety of the developed markets. However, interestingly, Europe and the UK, the more cyclical markets, i.e. more sensitive to changes in global economic growth, have outperformed the US over the last few months:
Equity market volatility is slowly subsiding but the underlying tug of war between “growth” and “value” continues. Since early November of last year “value” stocks, or markets, have been the outright winner, more than doubling the return of “growth” stocks in the US:
However, their leadership has not been consistent and there are signs that investor appetite to own theses areas of the markets may be fading. If we look at the performance of US value and growth, relative to the whole market, we can see that growth has slightly outperformed over the past three months:
So, what now? Well, we have long held the view that economic growth, particularly in the US and UK, would rebound sharply as vaccines are rolled out and economies re-open. We also hold the view that economic growth in the developed markets has likely peaked (at very high levels) and is likely to slow throughout the rest of this year and into next. Therefore, we have always felt that the recent rally in cyclical stocks would be fairly short lived and that the pre-pandemic regime of low inflation, slow economic growth and ultra-low interest rates would reassert itself.
If, and it’s a big if, we are right, the leadership in markets should rotate back into growth (i.e. technology etc) over the coming quarters. We expect this to be a gradual process, rather than the violent rotation that we witnessed late last year. Bond yields would recommence their drift downwards and the recent increase would be just another blip on their long-term trajectory:
If we are wrong and we see sustained higher inflation, bond yields would rise quickly and substantially, central banks would be forced to tighten monetary policy too quickly and market volatility would ensue.
We still think that central banks around the world are cognisant of the markets’ addiction to ultra-easy money and will be doing all that they can to avoid another 2013 style taper tantrum. Nonetheless, the risk of error is high and the risks are skewed to the downside more than at any point in the last 12-15 months.
Within client portfolios, we do not attempt to time the outperformance of one style of investment, region or asset class over another. We, as always, firmly believe in the power of proper portfolio construction, diversification and long-term investing. In a world where the focus seems to be on quarterly, monthly, or shorter return periods, it can be helpful to take step back form the day-to-day noise created by the market. It is prudent to remember that investing is for the long term and so we continue to advocate holding a balance of growth and value, equities and bonds and an appropriate exposure to all regions of the world in a well-balanced portfolio.
Finally, I wanted to touch on the developments in US President Biden’s infrastructure spending plans. As expected, the Republican party has pushed back hard against the circa $2trillion price tag, which is to be funded largely through corporation and personal tax increases. Bipartisan talks have largely stalled, and time is extremely short to get a version of the bill agreed given the Democrat’s target of the 4th July for passing a bill. This bill was and is extraordinarily ambitious and so it remains to be seen whether the Biden administration can get anything near the level of spending that they were aiming for through congress.
Elsewhere, a recent G7 agreement to back a global minimum tax rate of at least 15% and tax multinational companies in countries where they make money has not seemed to have any meaningful impact on stocks, so far. Goldman Sachs noted that while details and the path toward implementation remain unclear, such a policy would only have a small aggregate impact on S&P 500 earnings. Their team estimated that, absent any other tax reforms, a 15% global minimum tax rate would represent downside of just 1%-2% relative to current earnings estimates. Nonetheless, a global minimum tax rate is likely to go down well with voters as global corporations have hit the headlines over recent years for their payment of seemingly very low rates of tax.
Until next time, stay well.
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