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Market Insights, May 10, 2021

Each week, our Investment team shares its market views with you.

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Essentials

Another COVID-19 wave has hit Asia, with much more contagious variants spreading across the continent. The overall vaccination rate is low throughout the region, which is jeopardising the public health situation even though the pandemic has been handled well there so far. That will push back the reopening of borders and slow growth in countries that depend on international tourists.

The eurozone’s economic newsflow has been surprisingly robust, which has led to upward revisions in growth forecasts from their persistently low levels. With the vaccination campaign gaining momentum and the region’s recovery plan set to be implemented in the second half of the year, the European Commission raised its 2021 growth forecast from 3.8% to 4.4%.

With volatility returning to the markets, alternative fund managers have reduced their leverage, reflecting the start of a more cautious period. However, current levels are still far from those recorded in recent market dips.

Inflation is stirring

An uptick in annual inflation figures had been expected given the very unfavourable base effect for commodities – and especially energy – prices. That’s because oil prices plummeted in spring 2020 after the pandemic caused demand to sink. Energy prices are now back at their pre-crisis levels. And most other commodities are trading above their pre-COVID-19 prices. This is particularly true for most softs and a number of industrial metals, such as copper. In April, annualised consumer price rises were in line with expectations in Europe. Indeed, in most of the eurozone, inflation is slowly returning to the European Central Bank’s 2% target level.  And after several years of zero – or even negative – inflation, prices are unlikely to spiral out of control over the long term in the eurozone.

Things are different in the States, where price rises have outstripped economists’ expectations. Consumer prices were up 4.2% year over year, a level not seen since the summer of 2008. What’s more surprising is that core inflation (which excludes energy and food prices, which are more volatile) was up 4%, something we haven’t seen since 1995. These figures have caught investors’ attention and sparked renewed volatility on the stock markets. If this rise in consumer prices continues, it could prompt the US Federal Reserve to act earlier and being normalising monetary policy more quickly than expected.

The annual base effect will be very unfavourable again in May, so we may have to wait until the summer to determine whether this jump in consumer prices is a temporary blip or a longer-term trend. We’ll just have to see whether the Fed can wait that long. Investors will be going through the chair’s comments at the June meeting with a fine-tooth comb. The bond market has showed some resilience in recent days, but we still think that this new inflation scenario will push long-term US yields further up in the coming months.

USA – valuations look set to return to normal

The Q1 earnings season is nearing an end for US companies. And analysts have nothing to boast about when it comes to the accuracy of their forecasts – most of them were far too conservative once again. No fewer than 87% of S&P 500 companies beat the consensus, and they did so by a record 23%. Even the most optimistic analysts hadn’t expected the US economy to recover so quickly and decisively.

Yet, since mid-April, the stock markets have  been consolidating as they struggle to reach new highs. Are US equities running out of steam and now too expensive? Will the saying “sell in May and go away” hold true after the impressive rally that began more than a year ago? 

The market does need time to breathe, with investor sentiment nearing euphoric levels some weeks ago. But this should be a short-lived dip, and US equities should remain on a solid uptrend, since valuations aren’t as high as they appear. Earnings estimates for 2021 and 2022 are very much pointing upwards and stock market valuations should return to normal as analysts’ expectations catch up. We think that analysts are still too cautious, so we expect to see another record earnings seasons for Q2. Growth forecasts are rising more quickly than share prices, so we remain convinced that stock market valuations won’t hold equities back.

 

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