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Market Insights – July 19, 2021

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

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Essentials

US consumer confidence tumbled in July. This key sentiment indicator came in well below economists’ expectations. However, the relative decline in optimism was not reflected in retail sales, which remained robust and beat their July forecasts.

US inflation soared further in June. Consumer prices were up 5.4% year on year – a rate not seen for 13 years. But the bond market continued to defy all logic. 10-year Treasury yields dropped back under 1.30% despite the growing inflationary risk.  

The floods in Germany are the worst natural disaster the country has experienced in the post-war period. While the link between the heavy rains and global warming can’t be established for sure, climate change has become a major talking point again, particularly in the country’s election campaign, and investments aimed at combating climate change are growing at a faster pace.

USA – In a more mature phase of the cycle

While the USA was one of the first countries to make its way out of the pandemic, its economy may also be the first to show signs of slowing down. GDP growth likely peaked in the second quarter; from here on out, growth rates will probably return to normal as the favourable basis for comparison wears off. The same holds true for corporate earnings, whose growth looks set to stall in the second half of the year.

Can we really expect US share prices to continue on the same upward trend for the next six months? Probably not. Even though economic activity will probably stay strong for a few more quarters, any positive surprises from indicators or corporate earnings will become harder to find. And it’s these surprises – more so than growth figures in of themselves – that prompt upward revisions to forecasts and consequently lift share prices. 

We can therefore conclude that the USA, which is one step ahead of other world regions in the economic cycle, is now entering a more mature phase. As we suspected, the recent change in tone at the US Federal Reserve confirmed that the best is behind us when it comes to monetary policy as well.  Worries about inflation – hallmarks of a later phase of the economic cycle – will naturally prompt the Fed to scale back its asset purchases, probably before year-end. What’s more, a hike in interest rates is looking likely for 2023. 

That said, a more mature phase of the economic cycle doesn’t necessarily mean that the prices of risk assets won’t appreciate further. It’s clear that US stocks still have bright days ahead. While a more mature phase does indicate that returns will be lower, they will nevertheless be positive. Greater caution is called for, however, particularly in the choice of sector allocation. Investors will probably turn away from cyclical stocks, which have rallied considerably over the past year, and instead prefer stocks offering greater visibility at a time of growing uncertainty and rising volatility. We therefore recommend more balanced portfolios with exposure to both defensive and cyclical stocks. We also suggest gradually increasing exposure to growth stocks, since they tend to perform better when an economy shows the first signs of slowing.

A recovery that’s just getting started

Unlike in the USA, where GDP growth seems close to peaking, Europe’s economy is in the midst of an upswing. We think Europe’s recovery could prove to be more vigorous than expected, especially given the continent’s disappointing performance relative to other regions during the previous economic cycle. Pent-up demand is driving a rebound in consumer spending, and the sanguine state of the global economy is pushing up exports.

At the same time, the EU is about to embark on a major investment programme that should spur economic growth, particularly in sectors related to digitalisation and the energy transition. Governments in the EU have joined forces to create the programme, dubbed NextGenerationEU. The programme, coupled with the ECB’s resolutely accommodative monetary policy, will be a major advantage for the region. Against this backdrop, we remain bullish on eurozone equities despite their recent outperformance and the renewed near-term optimism on the part of investors. Given that European stocks have underperformed considerably since 2007, we don’t believe there’s a risk of euphoria among investors. Two factors are working in favour of European stocks: the earnings outlook in the region is extremely bright, and equities are fairly cheap compared with international peers. Within the eurozone, we have a positive outlook on Italy, which stands to benefit from both the ECB’s asset purchase programme and the EU’s recovery plan.

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