Market Insights - July 5, 2021

Growth in China’s services sector slowed in June, dragged down by an uptick in COVID-19 cases in the south of the country. The services PMI fell to 50.3, down from 55.1 in May. The sharp slowdown has been temporarily exacerbated by delays in the vaccine rollout, at a time when growth is expected to gradually return to normal levels.

The US bond market reacted surprisingly calmly to the June jobs figures. The number of new jobs remained high, at 850’000, and hourly wages were up 3.6% year on year, which could continue to fuel high inflation.

At their latest meeting, Opec members made steps towards an agreement to gradually ramp up production in 2021 but are more divided about what to do next year. Sentiment has become very optimistic recently, but we are maintaining our positive stance on oil in the medium term.

The recovery sets in

The economic recovery is gaining traction around the world, thanks to the biggest vaccination campaign in history. The USA, which was able to vaccinate a large portion of its population very early on, is reaping the benefits of having re-opened its domestic economy. The rebound was particularly strong in the second quarter, which saw double-digit GDP growth on an annualised basis. The pace should naturally slow in the second half of the year. But economies in Europe – followed by emerging markets – should then take over, as their vaccine rollout was slower off the mark.

Households in developed countries have built up huge amounts of savings during the pandemic, and that should underpin global growth in the coming months. Unless a new, vaccine-resistant variant emerges,the biggest threat to the financial markets in the coming months will be a sharp uptick in inflation. While the recent year-on-year jump in consumer prices was to be expected, given the extremely unfavourable comparison basis, we don’t want to see this trend turn into a lasting wage-price spiral. Among industrialised nations, only the US seems to have the perfect storm of conditions to trigger such a spiral.

If inflation conditions worsen, the Federal Reserve could start normalising monetary policy sooner. Apart from US inflation-linked bonds, the bond market currently offers little protection against the rising risk of inflation. Investors therefore still have to turn to the stock markets for potentially positive returns. Although stock markets had been heading sharply upwards since March 2020, they now seem to have entered a more mature phase, which is typically associated with relatively lower gains and greater volatility.

We are currently overweight on equities and have increased our exposure to Japan – a market that should soon catch up with its peers – and decreased our exposure to certain emerging markets (like those in Latin America) that could be hurt by a rise in US-dollar interest rates. We have scaled back the weighting of international real estate in our investment profiles due to unattractive valuations and the impact that the increase in remote working will have on the commercial property market. In terms of currencies, we have increased our exposure to the pound. We believe sterling is one of the world’s most undervalued currencies and that it should soon be strengthened by healthier fundamentals in the UK and a permanent resolution to Brexit.

Japan is catching up

It took several extensions to the state of emergency, four waves of COVID-19 infections and the upcoming Olympic Games to finally prompt the Japanese government to step up the pace of its vaccine rollout.

Although the absolute number of infections is small relative to other developed and Asian countries, Japan has introduced measures that restrict people’s movements and are putting the brakes on a rebound in consumer spending and economic output. Japanese exporters are well positioned to benefit from the global recovery, and the positive effects can already be seen in the upturn in the country’s manufacturing PMI.

In addition, the yen has fallen by over 6% against the dollar since the start of the year, providing a further boost to Japanese manufacturers. There has been a rotation towards cyclical stocks over the past few months. And Japan, along with the eurozone, is a region with a particularly cyclical equities market.

However, while European stocks gained over 6% in the second quarter, the Topix hardly budged. This underperformance largely reflects the Bank of Japan’s decision to scale back its ETF purchases, finally indicating a willingness to adjust its quantitative easing programme. The country’s sluggish vaccine rollout is another reason for the underperformance of its stock market, but now that the pace of the rollout has picked up – in an effort to protect Japanese citizens against the pandemic once and for all – the prospects for Japanese equities have brightened.