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Chief Investment Officer's team, 10.05.2021
The first week of May kept on combining overall positive economic data with spectacular earnings releases.
Starting with economic data, PMI reports highlighted strength in manufacturing activities and resilience in services, especially where vaccination rates are high. The monthly US employment report was however way below expectations, with 266,000 new jobs while the median forecast was close to a million. Unemployment rate unexpectedly rose to 6.1%. This didn’t prevent stock markets from reaching another all-time high, for at two reasons. First, the report shows more supply constraint than demand weakness. Second, the Fed has clearly expressed that a booming job market is a precondition to start reducing support, and market participants took note, with interest rates going lower.
On the stock markets’ side, returns were positive but not spectacularly so, especially as the earnings season show a +50% year-on-year increase in profits in Q1. This confirms our long-standing warning on the fact that investors’ positioning is already very optimistic.
So, should we “sell in May and go away”? We do not think so. Unanimously bullish positioning creates vulnerabilities, and we expect volatility ahead. However, the big picture remains very constructive for risk assets for 2021. If anything, strong earning help compressing the still elevated valuation multiples. This is why we have kept our tactical asset allocation unchanged in May. We are overweight stocks, underweight bonds, and neutral cash to stomach volatility, which is impossible to time, and seize future opportunities.
The week ahead will see monthly inflation numbers for the US and China, as well as US retail sales and various speeches from central banks. Stay safe.
An unexpectedly weak US jobs report triggered a flurry of reactions across asset classes, all of the kind of flavour that suggests at least temporary respite of the dominating theme of US exceptionalism. In layman’s language, a weaker than expected US labor market has further eased pressure on US yields, boosting long duration assets, from gold and technology stocks to EM debt, as well as currencies, which are sensitive to yield differentials now moving against the US dollar, so for instance both the euro and EM Forex shot higher. Has US growth peaked and are we going to see long duration come back into vogue? There is the possibility that in April American companies decided to bring back pre-crisis workforce, rather than making new hires, so as the expansion continues and new hires restart payrolls should rise in the next few months at a more sustained pace. Of course, our assumption, which is a largely shared one, that yields will rise with the labor market will be put to the test, though for now there is no reason to give in to what could be temporary factors. Meantime, markets will not be held back and will be waiting for a confirmation both in the form of stronger data and Fed comments about tapering before committing to US exceptionalism again.
This creates a window of opportunity for long-duration assets, which could last till the middle of June, the next FOMC meeting is scheduled for 14-15th, or at most the Jackson Hole Symposium, to be held in late August, when Powell is expected to broach the topic of the winding down of asset purchases. Investors should take notice that while the 10-year real yield collapsed, the nominal did not, hence in particular the euro, gold, EM FX and EM sovereigns rebounded strongly having a higher sensitivity to real rates. The common area currency could challenge this year’s highs at 1.23, while gold should find very strong resistance at the $1,900 area and EM Sovereigns should outperform US High-Yielding Corporates till US real rates remain subdued.
We strongly doubt that markets are committing to peaking US yields, as under this assumption we would find it odd that real rates tanked while nominals held their ground. The 10-year Treasury yield briefly dipped below 1.5% on Friday to end the week above where it was when the jobs report came out. Hence, we still hold the view that long-duration trades across asset classes should for now be more tactical than strategic. Janet Yellen said that rates “may have to rise somewhat” to keep the economy from overheating, though she subsequently toned down her message following negative market reactions. But it is all the more relevant that in the Fed’s just released Financial Stability Report concerns were expressed about the risks accompanying soaring financial asset prices. Misgivings about speculative behaviour would be weighing even more, in case Fed officials were to be caught off guard by not-so-transient inflationary pressures. Jeremy Siegel, long-standing-equity-bull Wharton professor, said on CNBC that the Fed could be forced sometime this year to change its monetary stance due to a spike in inflation.
Either way, due to financial or real asset inflation, negative second round effects on liquidity conditions should be advising some caution, on long-duration trades as well.
Fixed Income Update
Another week with the rates market on edge as traders look for more clues to decide the direction of the US Treasury yield movements. We had mentioned in the previous weekly that the employment number would remain a key indicator of FED’s actions in the future. The bad news on the employment front last week seems to have made FED’s position more assertive in the ongoing tug-of-war. The next couple of months will continue to give anxiety to the investors as we digest more macro data, with everyone looking forward to the Jackson Hole Symposium for clues on FED’s next set of actions. Meanwhile, we don’t see any significant risks to our overweight positions on the Emerging Markets Debt and High Yield. With the FED put continuing for the foreseeable future, we expect the riskier sub-sectors within the Fixed Income to continue to provide returns to the investors.
10-year US Treasury yields closed below 1.6% last week. However, intraday moves on Friday were highly volatile, with treasuries dropping 10 bps to 1.46% before going up to 1.56%. The weak employment data affected the 5 to 7 year part of the curve more as yields in that maturity bucket came down by c.10 bps. There is an expectation of some jumbo corporate primary market deals this week as firms emerge from the earnings blackout. The sub-asset classes finished the week in green. Emerging Market Debt spreads tightened by 5 bps and topped the weekly returns chart. Asia High Yield returned +0.4% last week as the concerns regarding the Huarong contagion subsided.
Fund flows into the fixed income asset class remained solid with +$13 Bn inflows last week. Investors avoided rates risk by piling into short-duration high yield and bank loan bonds. Emerging Market fund flows remained modest with only $ 565 Mn inflows. YTD defaults increased to 39. At this point in 2020 and 2019, there were 67 and 45 global defaults, of which only eight and five were from Europe. According to a report by S&P, year-to-date 2021, four sectors make up over half of global defaults: consumer products, media and entertainment, oil and gas, and retail and restaurants, according to a report by S&P.
MENA credits continue to perform well, with duration outperforming as yields remain stable. 30-year spreads of the Investment Grade sovereigns from the region compressed by 2 to 6 bps. High Yield sovereigns remained weak last week, with Egypt remaining the exception. Commercial Bank of Qatar issued a 5-year senior note priced to perfection at a 2.05% yield. Etisalat issued its first Euro-denominated bonds with solid investor demand. The current week will remain muted as the short work week should keep regional issuers out of the market.
The month of May is following a pattern set in late 2020/ early 2021. Global equities are progressively gaining, with year to date total returns at 10.5%, the recent uptick driven by bond yields and inflation fears temporarily receding. Value/ cyclicals have gone up at the expense of growth and tech and last week saw materials, energy and industrial sectors continue to lead. Reopening trades are outperforming COVID winners. The Nasdaq is now trailing the S&P 500 by over 6% year to date, though Friday saw a rebound of tech on a disappointing jobs report. The Dow Index, +2.7% for the week, with an industrial bias made new highs as did the S&P 500 +1.2% for the week. In Europe, the Stoxx 600 closed up 1.7%. A continued divergence between the performance of the Western economies where virus growth is slowing and Asia where India and Japan are dealing with strong virus resurgence. China trade issues and the tech crackdown are weighing on market performance, negative year to date. India’s Sensex surprisingly gained last week, though we increasingly see a near term impact from the reinstated lockdowns and slowdown of demand. Global supply chain issues should be kept in mind, and expect volatility: markets typically see three 5% drawdowns and one 10% drawdown every year.
UAE equities in line with energy, gained last week, adding to their already considerable year to date gains. PMI data indicates domestic demand is robust and real estate sales indicate end user buying is dominant, both adding to conviction on UAE consumer demand and non-oil growth. The capital markets are talking of new listings, much needed to boost trading volumes which have been low recently, partly a seasonal effect and also as the market needs broadening to attract international investors and increased participation in EM indices.
We remain overweight equities with a higher overweight for DM. The virus remains a concern with new variants in play, however vaccine efficacy should eventually prevail as seen in the UK and US. Our preference for the US in DM and Asia in EM equity allocation remains unchanged, as we think Asian equities should find a floor soon. The strong earning season in Europe and the US has seen equities in both regions up over 13% year to date. We expect markets will now move more on inflation news and central bank tapering possibilities. 80% of S&P 500 companies have reported Q1 earnings up 50% y/y, according to FactSet. Our overweight industrials and financials call continues and neutral tech. Healthcare where we are overweight, has been struggling. Vaccine makers which have had a spectacular one year rise, fell last week as the US said it will support plans at the World Trade Organization for a temporary waiver of patent protection for vaccines.
In addition to our recent thematic call on adding to global banks we recommend buying commodity companies as they resume profitability and reinstate dividends. On the ESG front we would add to companies that produce cultivated meat/ plant protein based milk substitutes as this significantly lowers the worlds carbon footprint.
Written By:Maurice Gravier Chief Investment Officer, [email protected]
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