Global Market Overview
In April, expectations for spectacular economic growth turned from forecast to fact, as the reopening of economies lifted developed market economic data. Markets spent much of the first quarter of the year positioning for such developments and, as such, faded the fact, with 10-year Treasury yields falling back from their March peak of 1.75% to 1.53%, before ending the month at 1.63%.
Equity markets had another strong month with developed market equities returning 4.7%. Beneath the headline indices, the rotation trade from growth to value took a breather in April, with growth stocks returning 6.3% and value stocks 3.2%. Regionally, the S&P 500 led the way, returning 5.3% on the month, while more cyclical markets such as the MSCI Europe ex-UK and the TOPIX in Japan lagged, returning 2.1% and -2.8%, respectively.
Covid-19 vaccine rollouts in the US and UK have continued to proceed well, with 44% and 51% of their respective populations now having received at least one dose, allowing for what looks like the start of a sustained reopening of their economies. In continental Europe, after a difficult start to the vaccine campaign it’s been encouraging to see that the pace of vaccination has accelerated significantly. Prospects for vaccine supply have improved, and by the end of April, the daily rate of vaccinations in major euro area member states had reached between 0.6% and 0.8% of the total population.
Emission reduction targets moved back into the spotlight in April with a wave of new commitments. The UK announced it would target reducing emissions by 78% by 2035, relative to 1990 levels, while President Biden announced the US would target a 50% reduction by 2030, relative to 2005 levels. China’s premier, Xi Jinping, also said that China’s coal consumption would peak in 2025.
President Biden’s first 100 days have now passed and the key takeaway for investors is that this president is not afraid to spend big. Following the passage of the American Rescue Plan – a USD 1.9 trillion stimulus package passed in March – the president has outlined his plans for two more spending packages. The USD 2.3 trillion American Jobs Plan is designed to invest in the country’s infrastructure, while the USD 1.8 trillion American Families Plan will aim to ensure a more equitable recovery, with many key tax credits from the Rescue bill being extended or made permanent.
The plans outline proposals to increase the corporate, top marginal income, and capital gains tax rates in order to pay for the spending. While the passage of the Rescue plan through Congress was fairly straightforward, these further plans are likely to be more contentious. It is likely that compromises will need to be made on both the spending and taxation proposals in order for the bills to pass.
With the vaccine rollout proceeding well and Covid-19 cases broadly under control, the US consumer has started to make up for lost time as the economy reopens. Consumers are feeling more confident, having saved about 8% of GDP in 2020 above what households normally put away, combined with the USD 1,400 stimulus cheques from the Biden administration. The Conference Board’s measure of confidence rebounded sharply from 109.0 to 121.7 in April.
This setup means that we are entering a period in which economic data will be exceptional – the US economy grew at an annualised pace of 6.4% in the first quarter and the pace of growth should accelerate from here. US retail sales grew 9.8% in March alone, and now sit 17% above the pre-pandemic level. Unsurprisingly food services & drinking places and clothing stores – two categories that have suffered most from the pandemic – saw some of the largest gains.
The pace of job growth is also accelerating – March saw 916,000 jobs added and the unemployment rate fell to 6.0%. But the Federal Reserve (Fed) chairman, Jerome Powell, was keen to stress at the April meeting that it will still be “some time” before the Fed sees “substantial further progress” towards its goal of maximum employment – one of the key criteria for the Fed to begin tapering its asset purchases.
The biggest question for markets in the second half of the year will be to what extent the rise in inflation is “transitory,” as the Fed has pre-emptively labelled it. The US Consumer Price Index (CPI) rose more than expected in March, increasing 0.6% month on month (m/m), while the core index increased by 0.3% m/m.
European countries have struggled to varying degrees to get on top of recent Covid-19 outbreaks, but cases in the region are heading in the right direction. The acceleration in the rate of vaccinations is welcome and gives us confidence that the economic recovery can begin in earnest in the second quarter, with peak growth expected in the third quarter as restrictions are loosened. In the meantime, the region should benefit from the increased demand for exports to the US, which account for 3% of eurozone GDP.
The eurozone economy contracted by 0.6% in the first quarter, but despite ongoing measures needed to contain the virus, there are signs that the economy has begun to grow again in April. With a return to normality in sight, consumers are feeling more optimistic and April’s measure of confidence rose more than expected. Spending has also proved resilient through the difficult winter with retail sales for February just 2.9% lower than a year ago.
Inflation remains more muted in the eurozone. Estimates for April showed that headline inflation rose to 1.6% year on year (y/y) but the core measure remains subdued at 0.8% y/y. The European Central Bank president, Christine Lagarde, indeed acknowledged that the eurozone and the US are on different pages when it comes to the economic and inflationary outlook and, as such, the ECB would not be acting in tandem with the Fed – a nod that the tapering of its bond purchases will likely be slower.
As in the US, Britons are starting to get out and enjoy themselves – retail sales excluding auto fuel rose 4.9% in March. Both the manufacturing and services PMI surveys came in above 60 for April indicating that the economy is rapidly growing. It has also been encouraging to see that Covid-19 cases remain at a low level, despite the relaxation of some restrictions. Now that an estimated 70% of adults have antibodies against the coronavirus, the UK should be on a sustainable path to reopening.
The Chinese economy continues to normalise. In the first quarter of the year it grew 0.6% quarter on quarter with a more balanced split across sectors, as activity in services continues to improve. Looking forward, domestic consumption is expected to be the major growth driver as fiscal and central bank authorities become more balanced in their policy support, which could lead to a deceleration in local government financing and infrastructure investment.
The Covid-19 health crisis in India tragically worsened in April, underscoring the need for successful vaccination rollouts to be urgently broadened out to the emerging world. Pressure on the health infrastructure has intensified and case fatality ratios have more than doubled since mid-February. Testing positivity ratios remain at an alarmingly high level of around 20%, leading states to continue imposing restrictions. As a result, levels of mobility have fallen back and the economy may now contract in the second quarter, pushing back the economic rebound until the second half of the year.
April proved to be a more challenging month on a relative basis for emerging markets which on average lagged their developed market counterparts. This was also the case in SA, where the ALSI only managed to eke out a gain of 1% compared to the MSCI ACWI’s 2.5% (in ZAR). Considering the slew of improving news on the political front locally, investors may have been a been disappointed with this return, but developed markets like the US were buoyed by an upbeat earnings season, while it was relative quiet on the local market.
Local investors should not read too much into the more muted performance in April because it is evident that there is plenty of momentum behind more cyclically orientated markets like SA at the moment. In fact, the ALSI’s gain of 1% in April was the 6th consecutive monthly gain. More importantly, many investors who have ignored local opportunities in favour of developed market opportunities may be surprised to know that since September, the ALSI has delivered a cumulative return of 27% compared to the S&P’s ZAR return of 7%. Ignoring currency fluctuations over this period and the ALSI is still ahead by 3%.
In April, the resource sector was a major contributor once again thanks to higher metal prices, but this time around it was the diversified miners that lead the charge as opposed to the PGM’. Market heavyweights like Naspers, British American Tobacco were the leading detractors, as were some of the platinum and gold producers.
Although EM markets lagged a bit, the upbeat environment for risk assets, along with improving terms of trade and a record trade surplus placed the Rand firmly in the sweet spot, gaining 1.8% against the US$. It would appear that in the short to medium term it may trade sub R14/$ if the environment remains favourable.
The property sector has been playing catchup of late and was once again the best performing local asset class, delivering a return of 11.7%. The real question on everyone’s mind is whether the sector has legs considering the headwinds that it faces. Local preference shares, which in recent years have mainly been driven by flows from high-net-worth individuals seeking lucrative after-tax yields, were also bid up and delivered an outstanding return of 9%.
The ALBI delivered a return of 1.9% while ILB’s were up 1.1%. Broadly speaking, local bonds have been on the backfoot for most of the year but have started to gather some momentum as US long dated yields have stabilized somewhat. Foreigners were net sellers of SA bonds approximately R10bn in April but outlook for both nominal and inflation linked bonds still appears favourable, especially if the carry trade takes hold and the “tourist investor” returns to the market like we have seen before when relative real yields are as high as they are today.
Inflation remains at the bottom end of the SARB’s target range, having increased marginally to 3.2% in March. With food and energy prices likely to push higher in the coming months due to both base effects and higher international prices, it is likely that CPI will increase intermittently. However, with local demand still quite weak, economist do not anticipate the rise in inflation to be sustained at significantly higher levels throughout the second half of the year.
Incoming economic growth data such as business surveys and the SARB’s leading indicator, suggest that economic growth in Q1’21 could have been stronger than market consensus. However, with constrained electricity supply, very little structural reform, and now poor implementation of the COVID vaccine roll-out, SA will grow below its potential.
Importantly, it is worth remembering that market returns typically react to changes in expectations and not expectations themselves. In fact, if anything the returns in the last year off the March lows are testament to that. With the SA economy expected to continue to benefit from a cyclical upturn in the commodity market and also the re-opening of our major trade partners such as Europe, there is plenty of upside should there be a marginal improvement in foreign sentiment towards SA as an investment destination.
We may soon, or have already, entered a new phase of the cyclical bull market in U.S. equities. This new phase will be characterized by higher price volatility but little or no P/E expansion. In other words, the most exciting part of the bull market is behind us and the path ahead towards higher prices will be driven by underlying corporate earnings, and accompanied by increasing risks and more frequent shakeouts. The developed world looks well on the path to recovery and the coming months should see spectacular economic data. All eyes will be on the degree to which inflationary pressures are as transitory as central bankers are flagging, or whether the growth impetus leads to more persistent price increases. Policymakers have worked tirelessly to provide enormous support to financial markets over the last year. The challenge now for central banks is to convince markets that they will continue to provide support, even when the global economy is booming.
Fund and Portfolios Overview
The Iza portfolios delivered a strong performance in April with all funds ahead of their peers at the close. Growth/quality came back from the Q1 set back due to the sharp rise in long end rates . Scottish Mortgage (10.73 %) , Smithson ( 6.88%) and Fundsmith ( 6.20 % ) all beat the equity benchmark MSCI World while the global property manager Catalyst also delivered a decent print ( 4.44%) . Gold staged a recovery on the back of a weaker dollar and more muted long term rates outlook. In the first phase of the bull market post the pandemic, capital returns primarily come from rising multiples. As such, portfolio beta, which is where P/E expansion is the most rampant was very important . In this new phase, investors should shift their focus to alpha. In other words, we believe it’s a stock picker’s market, and active managers should outperform a passive strategy, index funds and ETFs. From a macro perspective, sectorial valuation dispersion is still very high provides plenty of opportunities for sector rotations. Importantly investors should increase the overall quality of their portfolio. In Phase I, all stocks went up. In this next phase of the bull market, the market will discriminate, with lower quality companies beginning to lag. It will be very important for there to be sustainable improvement in earnings ( top and bottom line growth) to drive returns going forward .Something that’s is a key focus for the equity names in the Iza portfolios.