Positive surprises, tepid returns

Chief Investment Officer's team
02 May 2021
Positive surprises tepid returns
Both macro-economic data and corporate earnings were very positive last week


  • Both macro-economic data and corporate earnings were very positive last week
  • Analysts were too pessimistic, but markets had anticipated and didn’t rally
  • We hold our monthly Tactical Asset Allocation Committee this week

It was another week of upbeat data and modest market returns, which illustrates again that the constructive scenario for growth and earnings is widely consensual and at least partially priced -in by valuations.

Starting with economic data, first-quarter GDP reports confirmed strength in the US, Korea and Taiwan last week. The US printed a very strong 6.4% annualized growth, a clear acceleration from Q4’s 4.3%. Global growth should overall be lower than in Q3 however, with Euro area contracting and China decelerating. In the former, an acceleration in vaccinations is encouraging and in the latter, Caixin manufacturing PMI came out above expectations.

Corporate earnings for Q1 were an unambiguous bright spot. We are halfway through the season and the delivery is very strong, with more than 75% of global companies beating the EPS consensus. Big US tech was particularly shining, especially the big A, Alphabet, Amazon and Apple.

Despite the good news, stock indices were broadly unchanged, while interest rates ticked higher.

We keep on believing in a constructive outcome: economic vitality should prove a stronger force than expensive valuations. However, volatility is here to stay. So far our stance is to stomach the volatility, with an overweight in stocks versus bonds and hedge funds, while keeping cash on the side to be put at work on any material weakness.

The week ahead will bring important monthly economic data, especially PMI and the US job report. We will hold our monthly asset allocation meeting this week. Stay safe.

Cross-asset Update

Central banks once more set the stage for markets to continue to rally, at least in the next couple of months, till either even more dovishness comes to reinforce the customary dose, or there is a change of tone in their language, barring macroeconomic bumps which do not seem to be looming for now. The April FOMC meeting administered the usual benumbing, ‘all-is-fine’ message aimed at reassuring investors that Fed support is still there. And Christine Lagarde added fuel to the fire in the same direction, while discussing the situation of the EU economy.

It is striking how the Fed now wants to inculcate the impression that a rear-view-mirror stance is the only game in town, that is a policy tilt whereby only once inflation and unemployment have reached where the Fed deems appropriate some tightening is warranted. Jerome Powell has consistently made obvious efforts in that direction, this time carefully mentioning that “it’s not yet time” to even start talking about winding down asset purchases. The ECB president on her side mentioned a year of two halves, one where the recovery in the second half is going to be robust, but support must remain firmly in place. So, the new mantra in practice is that it is impossible to be behind the curve, hence central banks can afford to act late, while in the ‘old times’ it was that, being far too easy to fall behind the curve, pre-emptive action was all that mattered. Even laymen, knowing the golden rule that excesses are never good, will come to realise that we have just moved from one end of the excess spectrum to the other, it is just that we cannot know with any claim to precision when times will cease to be good for financial markets.

A backdrop marked by strong growth till 2021-end as per consensus projections and with the Fed’s reassurance as to policy support can only spur further risk-taking, considering also that for now the market is aligned with the Fed’s view that inflationary pressures are transient. After all, market-implied inflation gauges have just reached new highs for the year, while nominal rates have failed to keep up, so real rates have slightly dipped. Call it a reflationary or a goldilocks trade, this trade seems to be set to continue, in the form of a bull market for equities and credit, US yields moving sideways, hence a more extended rebound for gold, weakness in the US dollar and a sigh of relief for EM investors.

Investors will have to be watching out for a possible change of language at the next June FOMC meeting, which could be preparatory to Mr Powell’s more outspoken willingness to discuss the paring down of QE at the Jackson Hole Symposium in late August. In that case, with US growth peaking and the possibility of the withdrawal of liquidity in sight, markets could go through a temporary setback.

Fixed Income Update

As expected, FED stuck to its dovish tones in the last FOMC meeting. Investors would now look at how the FED’s tone changes looking at “Fedspeak” by analyzing the sound bites before the June FOMC meeting. The investors doubt FED’s assessments that inflation will be transitory. There is a combination of factors, including loss of monetary policy, unmatched fiscal stimulus, and ebbing infection numbers in the US, supporting such a hypothesis. The more important question is, do we see a break in the ranks of the FED? The latest comment from Dallas Federal Reserve Chairman Kaplan for FED to think about tapering is one such incident. However, we would do well to remember that the Dallas FED chairman is a non-voting member of the FOMC this year and has been one of the most hawkish officials in the FED. What has surprised investors is that these comments came barely a couple of days after Powell confirmed that the FED would not change its course any time soon.

The 10-year Treasury yields have gone up slightly last week and have traded in a range of 1.56% to 1.63%. The different asset classes reversed their recent trends, and most of the long-duration assets gave negative weekly returns. IG credit and developed market treasuries were the worst-performing. In contrast, High yield assets were in the green. US High Yield spreads continued their journey to the bottom and are trading at their tightest since 2007.

Weekly demand for Fixed Income Funds remained steady at +$14 Bn weekly net inflows. Investors pulled out money from the government bond funds and high yield funds as the spreads continue to grind tighter. Agg-type and short-duration bond funds cornered most of the fund flows. Fund flows to the emerging market bond funds remains modest and heavily geared towards the hard currency funds. As per the latest S&P report, the global default tally reached 37 after five new defaults last week. The US trailing-12-month speculative-grade corporate default rate fell for the third consecutive month to 6.3% in March 2021 from 6.4% in February 2021. EM HY default rate remains low at 2.4%.

MENA IG credits closed lower by -1% to -2.5%, with curves steepening. The belly of the curve continued to outperform the long-end. Moody’s changed the outlook of Bahrain’s sovereign ratings to “Negative,” citing the need for GCC Support to be upsized. High Yield credits were on the back foot last week, with Egypt continuing to lag amid speculation. Two sovereign-owned entities from the region Abu Dhabi Ports and OQ priced bonds the previous week with extensive order book coverages. Interestingly, OQ priced wider to the underlying sovereign curve by c.40 bps, and the bonds performed well in the secondary market.

Equity Update

Our overweight positioning on both developed and emerging market equities is working, as is our call on the US, however the overweight Asia call is not. The week saw global equities drop across the board, but the month of April saw significant gains with developed market equities up 4.7% and emerging markets gain 2.5%. Conflicting catalysts with virus cases in India increasing and mixed economic data were countered by encouraging earning releases that were indicative of a robust recovery with a strong global vaccination rollout. The 10-year US Treasury is managing to stay within a “safe” range and is not yet creating serious inflationary concerns, though the rise in copper prices is a cause of concern for input prices. Copper and cobalt are important Electric Vehicle raw materials and some analysts now predict that 50% of vehicles sold in 2030 will be EVs, positive for European automakers who are ahead on the EV model rollout. The global chip shortage continues to be a concern and may also lead to inflationary input pressure.

UAE equities had a good April and the Abu Dhabi and Dubai indices both gained over 3%. Last week saw them lose some ground in line with global equities, though banking sector results should boost sentiment while telecom results were a mixed bag. Asian markets have underperformed in April, though last week saw a flat performance from China equities in spite of an expanding Tech-sector crackdown in China. Chinese officials have called in 13 tech companies to rectify prominent problems on their platforms, as regulatory pressure on the fintech sector has extended beyond the Ant Group. A possible impact is that financing costs for larger fin-tech companies will rise, however some smaller players may get the chance to expand. European equities ended the week down half a percent, though had a good April. Good earnings from the banks Barclays and BNP Paribas and British pharmaceutical AstraZeneca whose, COVID-19 vaccine contributed significantly to sales.

US indices dropped from mid-week record highs to end the week marginally down. The S&P 500 has gained close to 12% this year and it’s a sustainable rally backed by 95% of the members currently above their 200 day moving average. Good news on the macro front: personal incomes gained with the aid of recent stimulus checks, consumer sentiment revised higher, and manufacturing activity in the Chicago region at decade highs along with robust Q1 GDP numbers. boosted by government stimulus spending and continued central bank monetary policy support. The US earnings calendar saw 300 S&P 500 companies report: with the majority topping revenue and earnings expectations. Sales growth is on track to be up 11.5% and earnings growth 52% above year ago levels. The economic effects of Covid-19 have taken tech titans Apple, Microsoft, Amazon, Facebook and Alphabet to declare record growth in revenue and profits. Apple announced a $ 90 bn share buyback as iPhone sales boosted revenue and profits. Amazon had a second quarter of revenue over $ 100 bn and looks on track to be the second company with over a $ 2 trillion valuation. A rise in digital ad spending led to a boost in Facebook and Alphabet earnings while Microsoft benefited from cloud and videogame services growth.

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