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Market Insights – April 12, 2021

Each week, a team of experts shares its market views with you!

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Essentials

Germany and France recorded an unexpected contraction in industrial output in February. This can be attributed to the two countries’ lockdowns, which have weighed on economic activity. But business confidence and order books have now improved, so manufacturing output should soon return to growth.

The UK’s quick and effective vaccine rollout means that the country can further ease restrictions, with all shops and pub gardens reopening. This is crucial for the economy, which has been one of the hardest hit by COVID-19 in Europe. Other sectors, such as aviation – and especially low-cost airlines – will be the next to reap the benefits.

Alternative funds once again performed well in March, as most managers have taken advantage of recent sector rotations on the stock markets. These funds recorded a year-on-year rise of around 4%, which is in line with global stock market indexes and well above bond markets performance.

USA: Spring is in the air for the econ-omy

In March 2020 – as pandemic-related panic gripped the markets – who would have thought that 12 months later, investors’ main concern would be that the US economy might overheat?

Throughout the various waves of infection, the successive relief packages for US households allowed consumers to build up their savings, which are now at levels not seen since the Second World War. So it’s very likely that once the US economy is fully open again, we’ll also see an explosion in consumer spending after more than a year of restrictions.

The much-awaited return to normal is now in sight. President Biden is hoping it will happen in time for the very symbolic Fourth of July. The vaccination campaign is in full swing across the country and is largely surpassing the targets Biden set at the start of his term. This achievement, which contrasts with the sluggish rollouts in other regions of the world, means we can rule out the possibility that another round of restrictions might derail the economic recovery. Forecasts are constantly being revised upwards by economists, with GDP growth expected to come in at almost 8% in 2021, although that figure may turn out to be too cautious.

Yet this unusually strong growth has raised fears that the US economy may overheat, which would lead to a surge in inflation. These fears can be put down to the sharp rise in US 10-year interest rates, which even strengthened in Q1, and the renewed volatility on the markets. Stock markets aren’t usually held back by a sharp rise in yields or by inflation of between 2% and 3%. But investors will have to get used to heightened volatility over the next few quarters, until inflation expectations level out.

Despite this bright outlook and the positive surprises we’re likely to see in terms of corporate earnings growth, we decided to maintain our relatively conservative stance on US equities. The upcoming recovery has already been largely priced in – most investors expect the economy to improve and are becoming increasingly bullish. That’s understandable, but we don’t think it’s the right time to increase our exposure to North American stock markets, which offer more limited upside than other markets.

Is inflation back for good?

This time last year, commodity prices slumped as a result of the public health crisis and the strict lockdowns that ensued. Oil prices briefly entered negative territory on the futures market, as supply outstripped demand, which plummeted. But the global economy has recovered well since then, prompting a solid rise in commodity prices. Pressure early on in the supply chain, coupled with a very unfavourable base effect, will be reflected in annual inflation figures over the next couple of months – consumer price indexes will almost certainly hit levels not seen for a very long time.

Will this be a temporary blip in the otherwise deeply disinflationary environment of the past 30-plus years? The rise in automation, robotics technology and online shopping will probably continue to keep a lid on prices, and globalisation will also continue to rein in inflation. In the current environment, we don’t think the price trend will be reversed indefinitely – at least not in Switzerland and the rest of Europe. But that could happen in the States, as Biden’s rescue plan will pump billions of dollars into the US economy, which is already well on the road to recovery and could end up overheating. 

Despite the Fed’s reassuring tone, the sharp rise in inflation expectations on the bond market shows that investors are worried. While we wait for these inflation fears to fade, we will continue to err on the side of caution when it comes to bond duration. Despite the recent rise in yields, we are still avoiding long-term government bonds, with the notable exception of inflation-linked US Treasuries, which should provide protection if consumer prices rise more sharply than expected.

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