After a decent week of returns last week, particularly for developed market equities, this week has seen slightly more choppy markets. While economic data remains solid, and the outlook remains positive, the persistence of the Covid-19 pandemic continues to weigh on sentiment from time to time. Yesterday also saw US equities react to potentially higher capital gains tax rates with the focus shifting from the positives around the new President’s stimulus packages to questioning how it will all be paid for.
Let’s start with the latest on the pandemic where the news remains mixed. The UK continues to see falling case numbers and continues on the path of normalisation that has allowed me to have a pint of beer, a caravan holiday and a much-needed haircut this past week. The UK case numbers are now back to the levels seen last September, before the B117 variant began to dominate. Whilst concerns remain over the widespread reopening of international travel, of which we will learn more next month, the domestic economy appears to be on track to continue to move through the phases of reopening through to the removal of all restrictions in June. Case numbers across Europe appear to be levelling off, and governments in France and the Netherlands are looking at an easing of restrictions in the coming weeks. The situation on vaccines is also improving in the EU, with France, Spain, Germany and Italy all having given a first vaccine to between 17% and 19% of their populations. These numbers are still some way behind the UK and US, on 49% and 40% respectively, but the supply chain stresses in the EU will continue to ease over the next few months. Data from Airfinity, a science information and analytics company, suggested that to the end of last week a total of 1 billion vaccines had been produced globally so far. They expect the next billion doses to be produced in the next month; this highlights the ramp up in production which will, in time, speed up the vaccine rollout across developed and emerging markets.
It is in the emerging markets where most of the concerns around case numbers lie for the moment. The spread of the P1 variant across Brazil and Latin America is well known but other countries such as Turkey and particularly India are seeing significant rises in case numbers. India has reported over 300,000 new cases for the past two days – these numbers have been estimated to be undercounting the real numbers by a factor of 10 so it comes as no surprise to see the healthcare system under extreme stress. Prime Minister Modi said a return to lockdowns would be a “last resort” and would not be needed so long as citizens took precautions. Much like Brazil, India is seeing the rapid spread of a new variant, and while it may be suppressed by vaccines, the vaccine rollout is not advanced enough to make a huge difference yet. This contrasts with the higher or elevated case numbers in the US and Europe where the feed through into hospitalisations and mortalities has been lower as a result of the most vulnerable having been vaccinated. While the development of the pandemic across emerging markets appears to have been largely ignored by financial markets, it serves as a reminder that the pandemic will continue to be a headwind for global growth and sectors of the economy that are more reliant on the normalisation of international travel and tourism.
Moving on to the economic data, and the flash PMI data published this morning continues to point to a strong economic rebound across western economies. The levels we are currently seeing tend to be associated with the topping of the economic cycle rather than the early stages of the recovery, but the PMI survey data has arguably been skewed more than normal as a result of the pandemic – this was no ordinary recession and the recovery, fuelled by fiscal and monetary support, is expected to accelerate over the course of the year as pent-up demand and savings feed into the economy. It was notable that the German PMI data highlighted delivery delays, highlighting the supply chain disruption that continues as a result of the pandemic and is most visible in semiconductor chip shortages leading to delays and pauses in auto manufacturing. In the UK, the inflation data was lower than expected for the second month in a row, with CPI at 0.7% year on year, driven by higher clothing and fuel prices. Producer prices in the UK climbed by 1.9%, which suggests that prices may not yet be getting passed on to end consumers. This week was the one-year anniversary of the oil price going negative and reminds us that base effects compared to Spring 2020 will see some spikes in a lot of the economic data in the coming weeks, not least the inflation data. The central banks continue to see this inflation as transitory, rather than persistent, and this message appears to have been heard in bond markets, where yields have stabilised after the rapid moves higher seen earlier this year. The UK unemployment data showed the unemployment rate falling to 4.9%, as a result of people stopping for work. The latest data shows 4.65 million people still on furlough, well down on the peak of 8.8 million last April but still a significant number when the scheme only has a few more months left to run. China announced first quarter economic growth of 18.3% compared to the first quarter of 2020, which was dominated by the Covid-19 outbreak. This was slightly lower than expected, and in terms of quarterly growth, looks relatively subdued at only 0.6%. There appears to be a consensus that Chinese policy tightening may have gone too far in slowing the economy, so we are watching for any signs of a loosening in policy to allow the economy to reaccelerate.
In politics, the US ramped up sanctions on Russia and expelled ten Russian diplomats, as well as restricting US entities investing in Russian debt issuance. This is as a result of the Russian interference in the US elections. President Biden said that Russia’s actions such as “efforts to undermine the conduct of free and fair democratic elections” constituted an “unusual and extraordinary threat to the national security, foreign policy and economy of the US”. Russian domestic politics have also been in focus, with jailed opposition leader Alexei Navalny on hunger strike and Biden warning of “consequences” should anything happen to him. With President Biden approaching 100 days in office, he is yet to face any significant foreign policy tests, but this benign period in geopolitics may not continue in perpetuity. In the short term, the news yesterday that Russian troops deployed close to the Ukrainian border will return to their barracks should help calm nerves.
The news from the central banks has been relatively quiet. The European Central Bank (ECB) meeting yesterday delivered no surprises or policy changes; a review of the pace of asset purchases will take place at the next meeting in June so expectations were low for any changes this time. Last week, ECB President Christine Lagarde said that the eurozone economy was still standing on the “two crutches” of monetary and fiscal policy and “neither should be removed until there is a full recovery”. In the US, Federal Reserve Chair Jay Powell told CBS News that the economy was at an “inflection point” where the economy is “about to start growing much more quickly” with “job creation coming in much more quickly”. He sounded more cautious on the “8.5-9 million people, maybe even more that were working before the pandemic and have lost their jobs”. Powell said that “markets focus too much on what we call the economic predictions, and I would focus on the outcomes”. Once again, the Fed is making clear they are happy to be patient and allow the economy to ‘run hot’ rather than pre-emptively begin to tighten policy, risking the economic (and financial market) recovery.
In terms of our positioning, we remain somewhat circumspect for the moment, on the basis of the market moves we have seen in recent months. Valuations and sentiment indicators look stretched, which we see as further justifying our more cautious view on financial markets, though we remain cognisant that the economic outlook remains positive and supportive tailwinds from the central banks and fiscal policy remain in place. A correction from current market levels would not come as a surprise, and a correction appears more likely than anything more dramatic in the absence of a catalyst such as a rate hike or a economic recession.
We are also mindful of the persistent risks from the pandemic, and also of geopolitical concerns amidst rising rhetoric between the US and Russia. That said, we still see strength in corporate earnings and the overcoming of the pandemic as reasons to still expect equities to make progress, but we do think that in the near term, a pull back from such extremes in valuations and sentiment indicators would not be a surprise. Our regional positioning remains unchanged, though we will be looking closely at China in our upcoming Asia/Emerging Markets review for signs of an economic pickup. For the moment, we remain slightly overweight in Asia and neutral in Emerging Markets. We continue to be overweight the UK, and underweight Japan, the US and Europe. Overall, our underweights in both equities and fixed income means that we continue to have exposure to selected absolute return and specialist portfolios where we see attractive potential returns.