Investment Outlook - Market Update
Global equity markets delivered exceptional returns for the first half of 2021. A very strong first quarter was followed by yet another strong second quarter. A focus on improving growth fundamentals, hopes for some inflation and a reopening of the world economy were all strong drivers. At the same time central banks remained supportive and an abundance of excess liquidity continued to pour into both bond and equity markets.
Our central scenario remains that the global economy will maintain its strong trajectory with the associated reopening, reflation and associated style/sector rotations within equity markets. There are however risks associated with this scenario and not least inflation concerns that dominated over the earlier months of the year only to fade of late and on the other side concerns that the economic recovery itself will fade. While both extremes are possible we assign lower probabilities but acknowledge this dynamic could pose a major challenge for the US Federal Reserve and not just its actions but also its rhetoric over coming months. It does not wish to have a repeat of the ‘taper tantrum’ of 2013 when the Fed rhetoric at the time unnerved markets and caused quite a negative market reaction. This is certainly a new risk to highlight and a balancing act that lies ahead for the Fed and its chairman.
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 alternate assets. We also note that despite a recovery in value and cyclical equities year-to-date, that the valuation extremes of growth equities persists and value and income equities are trading at considerable discounts compared to history.
We do expect that the upcoming Q2 2021 earnings reporting season will be extremely strong. Company narrative will be important for both market sentiment as well as setting the tone and expectations for earnings revisions and dividend expectation for the remainder of the year. Company management teams are now back on the front foot and will look to articulate how they grow from here and deploy capital yet again. As part of this we have seen strong M&A activity and this is, we believe, likely to continue
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 we also expect a renewed focus on the attraction of attractively-priced equity dividend income.
Despite some evidence of upward pressure on bond yields so far this year, they remain extremely overvalued and close to historically low yield levels. As has been the case for years, bond markets remain ‘artificially’ supported by central bank intervention and are not reflective, we believe, of their true fundamental value. Over coming months the Fed will have to walk a fine line, be it signalling likely interest rate rises and/or that it will begin tapering excess liquidity on the one hand while maintaining stability and lower-for-longer government bond yields on the other. On balance, we do expect bond markets themselves will continue to struggle against such a fundamentally healthy backdrop.