Investment Outlook - Market Update
Following a tumultuous 2020, we entered 2021 with much hope and anticipation of better times ahead and a world that would confidently begin to ‘normalise’. The first quarter was an exceptionally strong quarter for global equity markets, with the 12 month returns recorded to mid-April being amongst the best recorded in over 100 years! So far so very good
Our central scenario remains that from late spring onwards both the global economy and company earnings will experience strong growth. We expect to see ‘red-hot’ economic growth numbers from the US , to be followed later in the summer by Europe. The highly accommodative policy mix, both fiscal and monetary remains in-situ, but overtaken in 2021 by a more dominant focus on fundamentals as we expected. This should remain and not just support equity markets themselves, but more materially support a continued rotation to ‘new winners’ such as value and cyclical oriented equity stocks and sectors. Consistent with this environment, we expect bond markets to continue to struggle and underperform as yields remain under upward pressure. Such yield rises may be moderate however as the US Fed could not be clearer that they will remain patient and keep rates ‘lower for longer’ as they view any inflation pressures as ‘temporary’. Against this however, Biden’s US fiscal stimulus is a significantly bigger than expected policy development.
With equity markets trading near all time highs, it does feel like most of the strong gains are already behind us. The markets to a large extent have already factored in the anticipated strong macro growth leaving little room for positive surprise. So while market returns themselves should be more modest, the key focus is likely to be on bottom-up company fundamentals with the key driver likely to be earnings growth and momentum of same.
As ever, uncertainties remain and not least with the path of the Covid epidemic, potentially more virulent strains and the challenges to both the efficacy and delivery of currently available vaccines. For a decade authorities have battled and investors feared deflation. That rhetoric itself has also rotated to a current fear of a resumption of inflation and what that would mean for investors. To date, whilst a moderate fear we have seen how it can quickly undermine bond markets. We will also continue to monitor geo-politics and not least the potential for an escalation in China-US tensions.
Asset class outlook:
At an aggregate valuation level equity markets are expensive compared to history. For now, at least, there is little on the horizon to change this. We continue to note that equities are attractive compared to the alternates such as bonds. We also note that it’s the valuation extremes of growth equites that is of most concern within equity markets with value and income equities trading at considerable discounts compared to history.
As fundamentals now matter once again, the upcoming Q1 2021 earnings reporting season will be important for both market sentiment as well as setting the tone and expectations of earnings momentum for the remainder of the year. 12 months ago, the market focus was on the ‘survivability’ of companies with questions targeted on liquidity and balance sheet strength. Over coming weeks expect a radical change of focus towards improved visibility, positive earnings momentum and confidence as management outline their growth plans.
We believe that the rotation towards cyclical and value sectors is far from complete as we now enter an environment that should better reward stock-picking. As the year progresses and bond yields likely drift higher again, that next phase may then be one where attractively priced equity dividend income could well be sought and rewarded.
Despite rising yields so far this year, government bonds remain extremely overvalued as they remain close to historically low yield levels. Bond markets remain ‘artificially’ supported by central bank intervention and are at present not reflective, we believe, of their true fundamental value. At the margin, while not disappearing, this excess liquidity is peaking and should serve to undermine bonds as an asset class. Any negative inflation spikes will certainly challenge bond market mood music!