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June 2021 Monthly Market Commentary: Strong global economic data despite Covid variant threat

Market Context: Strong global economic data despite Covid variant threat

Global Macro:

Global macroeconomic data continued to be positive in June in most regions of the world. The US labor report for the month showed nonfarm payrolls increasing by 850k, beating consensus expectations of 700k, while the unemployment rate stabilized just under 6% (5.9% in June; vs consensus: 5.7%). As the economic situation normalizes in the US, the Federal Reserve signaled two potential rate hikes in 2023. As such, the range of the Fed funds rate could increase from 0-0.25% at present to 0.25-0.50% then 0.50-0.75% by end-2023. Meanwhile, annual inflation in the Eurozone eased to 1.9% YoY in June (vs 2.0% in May). We believe the rise in inflation witnessed in the US since the beginning of the year – largely driven by higher energy prices, Covid-related supply disruptions, and a low-base effect – will also start to ease from June onwards. In the meantime, China has experienced the strongest economic recovery in the world with retail sales up 15% YoY and exports growing 30% YoY on the back of pent-up external demand. The manufacturing and services sectors continue to expand rapidly. Overall, China’s GDP increased 18.3% YoY in Q1 2021, beating all other major economies. On the pandemic front, vaccination has made significant progress in Europe, North America, and China. However, the spread of new, more aggressive Covid-19 variants, in particular the Delta variant, could delay the full reopening of most economies.

Financial Markets: 

The overall global macro environment remains positive for risky assets in general and equity markets in particular. We believe financial markets are benefiting from three main factors: first, the progressive reopening of economies, country by country, which will underpin economic growth and corporate earnings; second, the fact that inflation is most likely temporary; and third, central banks’ accommodative monetary policy, which will continue to support the economy in the foreseeable future.

Equity: Month to date the S&P 500 rose 1.8% amid the US strong economic rebound; Euro Stoxx 50 +0.2%, Hang Seng Index -1.1%. Fixed Income: The 10-year US yield further contracted 10bps in June to 1.48%, which contributed to the rise in Emerging Market government bonds denominated in USD (+0.3%; vs -0.9% in local currencies). High-yield corporate bonds also increased 0.4% in EUR and 1.2% in USD. Currencies: The US dollar regained strength in June, following a Fed meeting that pointed to earlier-than-expected policy tightening: EUR -2.5%, CNY -1.3%, AUD -3.0%; safe-haven JPY -0.8%, CHF -2.5%. Commodities: Oil prices continued to rally in June amid the global recovery while gold suffered from the US dollar strength: WTI Oil +9.9%, Gold -7.7%.

Risks:

 The main risk to the global economy is the increase in Covid-19 variant cases around the world. At this stage, the total number of new cases is declining but a potential new wave of infections remains the main headwind to the economic recovery.

  • Covid-19 variants: A new wave of infections caused by stronger Covid variants would result in new restrictions and lockdown measures around the world, with a strong negative impact on the economic growth outlook.
  • Rising long-term interest rates: 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 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.
  • 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:

  • Chinese equities: We believe large valuation discrepancies between the US and other major markets are not justified by current and anticipated fundamental data. China’s GDP expanded 18.3% YoY in Q1, vs +0.4% only in the US. Meanwhile, the US budget deficit surged over the period due to the government’s massive spending plan. As the manufacturer of the world, China seems to benefit the most from the US stimulus. Nonetheless, the S&P 500 is up 15% year to date whereas the Hang Seng China Enterprises Index is down 0.7%. Although this can be explained to some extent by US sanctions as well as China’s less accommodative monetary policy to avoid asset bubbles, we think the valuation discrepancy between US equities and Chinese equities will narrow to more realistic levels.
  • Oil & Gas: The energy sector is a major beneficiary of the global recovery, while long-term anticipated oil demand remains robust. Moreover, we expect energy companies to resume share buybacks and dividend payments, which would be a catalyst for their share price.
  • 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 above-market dividend yields following their central bank’s green light.
  • 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, China became the number one country in the world for Foreign Direct Investments in 2020 according to the UN, 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.