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Chief Investment Officer's team, 11.04.2021
The early days of the second quarter show a strong start for financial markets, one year after most of the world went into lockdown. So far in Q2, all major asset classes are in the green, including bonds. Most economic data is signalling a surge in global GDP for the rest of 2021, with the US being the clear regional leader for the current quarter. No doubt, inflation should rise against such a booming backdrop, and last week's PPI was already higher than consensus expectations. However, market participants didn't care that much and preferred to enjoy the minutes of the FOMC meeting which confirmed a patient, i.e. dovish, stance.
Yet, divergences are becoming more apparent. Brazil, India and the Euro area are still struggling with the second wave of the virus, and lagging the countries where vaccination programs have been more effective. The performance hierarchy is already differentiating: the US and the UK outperform other developed markets, and interestingly, the GCC is the best performer of 2021 so far within emerging regions, with a +15% gain year-to-date. Looking at the largest emerging country, the MSCI China is more or less unchanged this year so far. It is not that much about the virus, but about the sequence of growth: the economic rebound started there a year ago, much earlier than anywhere else. Looking forward, growth should downshift in the coming quarters as some fiscal and credit policy support measures are already being removed. By contrast, the US is still in the early days of its massive stimulus.
Bottom line, differences should narrow later this year as the breadth of growth widens. We remain reasonably constructive and will hold our monthly asset allocation committee this week. Stay safe.
The global economy should have just entered the most favourable quarters in terms of real growth, with Q2 and Q3 seeing the highest sequential expansion rates in the United States and in Europe, and China holding steady or gradually slowing down into year-end after leading the recovery phase in 2020. The IMF, usually acknowledging change once it becomes too glaring to ignore, upgraded its forecast for 2021 world growth to its highest level in four decades. Business confidence releases for March saw the Global PMI at a 7-year high, with US Services reaching its highest level ever and Euro Area PMIs well above expectations and at all-time highs as well. Since not all of the US stimulus has been deployed yet, and Europe still has to unleash its full potential as for now entangled in painful lockdowns, more upside surprises could well be in store. While it is true that business confidence tends to peak 10-to-11 months after the end of a recession, it is also true that with more support in the pipeline the Purchasing Manager Indices should linger at sustained levels in the next few quarters. Also, the yield curve tends to lead the business cycle and more steepening seems to be warranted, hence even inflection points in PMIs could actually be far from being round the corner.
Financial assets seem to have discounted the rosy scenario to a good extent, with the easy money behind us, but with more stock market gains to come. Equity reflation trades, like Cyclical-to-Defensives and Value-to-Growth, have played out as expected tracking progress in the Global Manufacturing PMI Index. If business confidence stays at elevated levels as argued above, then the reflation themes should have more room to run. At the same time, portfolio views should now be more nuanced and we encourage clients to find pockets of value at the security or sub-sector level, rather than follow broad, clear-cut themes, as in financial markets the more obvious trades tend to be less easily rewarded.
Insofar as US yields will tend to rise, dollar-centric assets and first and foremost the global reserve currency should keep on outperforming; in short, US exceptionalism seems set to continue. Although our US Dollar Risk Appetite Indicator had timely indicated a US dollar revival, we hesitated to fully embrace the signal due to the very dovish Fed policy constraining short-dated Treasury yields, which tend to matter most for currency movements. But markets have so far thought otherwise, focusing on the role of the United States leading the growth efforts now that China is past its growth peak in this cycle. So, dollar strength should not be over yet, in particular against DM FX where central banks remain dovish, that is EUR, CHF and JPY, in spite of the pause taken last week as real rates consolidated.
Overall, broad US exceptionalism, equity gains though no longer so obviously clear-cut in terms of reflation themes as well as selective dollar strength should be here to stay in the next few quarters.
Fixed Income Update
The question most of the investors ask us currently is if the 10-year US Treasury yield movement has topped out. While predicting the top of any security is more of guesswork than an exact science, we would go out on a limb to say that most of the yield movement for the year is in the rear-view mirror. The c. 80 bps YTD uptick has had a considerable effect on different sub-sectors. The 10-year Treasury has traded between 1.6% and 1.8% for the last month since crossing the dreaded 1.6% mark on 12th March. All eyes will be on Tuesday's release of the US consumer price index for March, which is expected to show a significant jump. It will be interesting to observe if the bond markets dismiss the higher numbers as they did with last Friday's stronger-than-projected producer price data.
We detailed our view for the quarter in the last weekly. We continue to believe that the yields should be range-bound for the rest of the year in the 1.6%-2% range in our base case scenario. The closer we get to 2%, it would benefit the investors to go long duration and start looking at EM Sovereign debt and LatAm debt which have been the worst-performing subsectors.
Once again, the sub-asset classes moved in sync with the yield curve movement as spreads remain grounded. US High yield is currently trading at the lowest spread in more than a decade and approaching the lows of 2007. On the other hand, this year's best sub-asset class, pan-European HY, is still trading at 100 bps wider to 2007 levels. However, the explicit FED support means we don't see significant outperformance of European HY from now on since US HY has more cyclical issuers.
Clients should take a position in global HY funds rather than taking regional bets within Developed Markets. For total returns, we still prefer Asia HY for the year with spreads above 600 bps. The 2021 global corporate default tally has reached 26. This year's tally is less than two-thirds of the count at the same point in 2020 when credit stress rapidly increased due to the COVID-19 pandemic.
It was a good week for fund flows into Fixed income, which crossed $16 Bn last week for the first time since Feb. The increase reflected greater net inflows into Agg-type products and hard currency EM bond funds. Investors continued to net sell IG credit products and long-duration funds in line with our views.
The GCC bond markets had a sedate week due to a holiday-shortened week in Asia. There were no new deals announced last week, and the much-awaited DIB AT1 perpetual Sukuk was postponed. Investors anticipate the deal to hit the market this week before we go into the Holy month of Ramadan.
A positive week for global markets, in spite of the Chinese tech companies sell off and the Archegos trading saga. Developed market equities are powering ahead while emerging markets have given back some of their gains. The MSCI China is now flat year to date. US equities were higher for a third consecutive week, setting new records and have seen nine consecutive weeks of inflows. Countries with the stronger vaccine rollout, which include the UK and the UAE have been outperforming. Globally, all sectors ended the week positive except for energy, with a rebound in high growth sectors such as tech, as 10 Year Treasury yields stabilized. The Nasdaq is up almost 5% this month so far. US exceptionalism in the stock markets continues on expectations of a strong economic recovery, with the World Bank upgrading its growth forecasts. The Q1 earnings season kicks off next week with the banks. Consensus estimates are for earnings growth for Q1 for the S&P 500 at 21.3% with the strongest earnings growth from the Financials, Consumer Disc., Materials, and Tech sectors. Also giving a boost to equities is a comment from JP Morgan CEO Jamie Dimon that strong consumer savings, expanded vaccine distribution and the proposed $2.3 tn infrastructure plan could lead to a "Goldilocks" economy of fast, sustained growth alongside inflation and interest rates that drift slowly upward. Technical indicators are supportive of US markets with the Vix at low levels and the DJ Transportation Index and the Semiconductor Index at record levels. However, the music will stop at some point, the S&P 500 has already gained over 10% year to date (total returns), our fair value has been achieved, so stay selective, with quality names and diversified as the shift between cyclical and growth factors will continue.
UAE markets are up almost 16% this year, with higher dividend stocks in the lead. Valuations are still attractive for banks and the UAE overall. The Abu Dhabi Index leads as it has a higher weight of telecom and banking and lower real estate. Whilst tourism arrivals have led to hotel occupancy improving the real estate stocks have lagged the overall UAE market. What will help are dividends reinstated for Dubai developers and the supply demand situation improving. With the recent visa relaxations for long term residents there are more end buyers in the market. The KSA index continues its recent upward move. The completion of the merger between NCB and Samba has led to the creation of the Saudi National Bank (SNB) which will benefit from merger synergies. We remain bullish financials and telecom.
Chinese regulators fined Alibaba $ 2.8 bn i.e. 4% of its 2019 revenues as they conclude an antitrust investigation. Chinese stocks have dropped 16% since the Feb peak and China tech stocks 23% on growing concerns of possible delisting from US exchanges and increased regulatory scrutiny from China authorities, with reported plans to take control of companies' user data. US tech on the other hand fell in end Feb, but has rebounded sharply to new highs. We would prefer US tech companies currently as they are more global in nature.
Written By:Maurice Gravier Chief Investment Officer, [email protected]
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