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April 2021 Monthly Market Commentary: Desynchronized Economic Recovery

Market Context: Desynchronized Economic Recovery

Global Macro:

The global economy is bouncing back, entering a reflation period characterized by accelerating growth as well as rising interest rates and inflation, although we believe the rise in inflation will be moderate as salaries are unlikely to increase in a more and more uberized world. Vaccination programs have been the main catalyst for the global economic recovery. However, we note the recovery has been uneven among world regions. China is ahead of other countries: its economy in fully back on track with a 2021 expected growth of 9%. In the US, the economic activity has recovered 80% of its 2019 level with a 2021 expected growth of 6.9%, while in Europe, the activity has only recovered 65% of its 2019 level with a 2021 expected growth of 4.3%. Most central banks around the world continue to guarantee low short-term rates for the years to come, with the US Federal Reserve and European Central Bank (ECB) keeping their monetary policy unchanged following April’s meetings. By contrast, People’s Bank of China (PBoC) has already started to taper monetary liquidity injections in order to control the level of debt in private sectors, such as real estate. Meanwhile, in an effort to curb their ballooning debt following massive stimulus plans, governments around the world are contemplating tax hikes.

Financial Markets: 

We believe the current reflationary environment will benefit cyclical assets, such as financial and energy stocks, more than sectors like technology. Strong growth and low interest rates are supporting the expensive US equity market, with the S&P 500 almost tripling since its pre-2008 crisis level. In contrast, Chinese and European equity indices are barely back to their pre-2008 level. Continuously rising earnings per share, companies’ share buy-backs, and the market dominance of US digital platforms are some of the reasons that explain the outperformance of the US equity market. Nonetheless, we think China’s economic outperformance with respect to the rest of the world, its momentum, and its head start in the new economic cycle would justify a correction of the equity valuation gap with the US. Although Chinese equities have suffered from US sanctions that imposed a ban on investments in certain Chinese stocks for US persons – both individuals and companies – which still represent the largest investor group in the world, we believe corporate tax hikes in the US and on US companies abroad might be one of the catalysts for a correction.

Equity: Month to date the S&P 500 rallied 5.3%, underpinned by the US’ strong economic recovery amid a rapid vaccination rollout; Euro Stoxx 50 +1.4%, Hang Seng Index +1.2%. Fixed Income: The 10-year US yield contracted 12bps in April to 1.63%, which contributed to the rebound of Emerging Market government bonds (+1.9% in USD and +2.2% in local currencies). High-yield corporate bonds also rose 0.1% in EUR and 0.8% in USD. Currencies: The US dollar resumed its bearish trend as US yields seemed to stabilize: EUR +2.5%, CNY +1.2%, AUD +1.6%; safe-haven JPY +1.2%, CHF +3.3%. Commodities: Both oil and gold prices went up in April amid the global reflationary environment: WTI Oil +6.7%, Gold +3.6%.

Risks: 

  • Covid-19: New restrictions around the world would have a negative impact on the economic growth outlook.
  • US Tech bubble & high US equity valuations: Tech stocks remain under pressure, given the highest valuations since the dot-com era and high market concentration, while the Biden administration is expected to take a much stronger stance on the tax and anti-trust treatment of Tech companies.
  • Bankruptcy wave: Although government intervention has been able to limit the effect of the pandemic on business closures in some parts of the world, especially in Europe, the risk of a bankruptcy wave remains high. In the US, chapter 7 and 11 bankruptcy filings for public and private companies with liabilities over US$50m jumped 69% year on year in 2020, reaching a new high since 2009.
  • Long-term interest rate hikes: We expect central banks to start reducing cash injections and tapering their bond purchasing programs within the next 12 to 18 months, which will result in higher interest rates and downward pressure on equity valuations. Meanwhile, investors are requiring higher yields to compensate for the risk of governments’ ballooning debt.
  • US-China tensions: US-China trade frictions remain strong, with increasing tension around Taiwan and the South China Sea. In addition, the US is maintaining pressure on Chinese companies listed on US stock exchanges by implementing stricter rules targeting Chinese firms.

Opportunities:

  • China H-shares: We believe H-shares’ upside potential remains intact given China’s growth dynamic and relatively cheap equity valuations, below their 2018 highs. Moreover, the composition of the Hang Seng Index is changing in 2021 with an increase in the number of components while the proportion of sectors participating in the digital transformation rises and cyclical stocks, such as financials and property stocks, remain a substantial part of the index. We expect the Hang Seng Index to benefit from the long-term trend of digital transformation, the cyclical sector rotation, and the reflationary recovery of 2021 and 2022.
  • Financials: We expect the financial sector to benefit from the reflationary environment of higher yields and a steeper yield curve, but also from stronger growth via a reduction in nonperforming loans and the positive impact from lower loan provisions on earnings revisions. This would be positive for both the banking and the insurance sectors, where valuations continue to look attractive. We think stocks of well-capitalized quality banks in the US, Europe, Hong Kong, and Japan will pay an above-market dividend yield following their central bank’s green light.
  • Oil & Gas: The sector partly recovered in 2020, yet still trades at half the book value of the market, its lowest level since 1928, and is lagging the oil recovery. We are seeing more interest from investors towards major energy players that are implementing green energy programs to transition from fossil fuels to clean, sustainable energy production, thus making them major decarbonization contributors.
  • Chinese Yuan: The RMB reflects the forward growth of the Chinese economy and the increase in global trade and investments in RMB. The Yuan is also becoming an important reserve currency for central banks and financial institutions, underpinned by China’s strong economic fundamentals: a large positive commercial balance, growing domestic consumption, and interest rates at 3% vs close to 0% in Western economies. Moreover, the UN announced that China became the number one country in the world for Foreign Direct Investments in 2020, with growing inflows from investors buying Chinese stocks, bonds, and hard assets contributing to the strengthening of the renminbi and consolidating its role as a major trade currency.