Global Market Overview
The drop in infections and the rapid vaccination rollout continued to drive markets higher in February. The UK and US are progressing well with their vaccination programmes and could achieve a large-scale reopening of their economies in the second half of the year. However, virus mutations, such as the Brazilian and South African variants, could still potentially slow down the return to normality.
On the macroeconomic front, despite the need to maintain some social distancing measures, manufacturing surveys continue to show solid momentum, aided by extended fiscal support, which is boosting demand for goods. The expected approval of President Biden’s fiscal programme should boost the US recovery with positive spill over effects. However, government spending is creating a concern around potential inflation. Core government bond yields are rising as markets price in higher future growth and inflation expectations.
Equity markets closed the month with positive returns, despite a drop towards the end of the month. The rotation in favour of value and small caps continued as a result of the expected post-pandemic normalisation and rising bond yields. Bond market news in February was dominated by increasing rates and reflation. Investors appeared to be projecting at least a period of increasing rates and economic reflation resulting from pending additional fiscal stimulus from Congress, increasing consumer prices that would accompany economic growth, and improving employment, among other influences. In comments released during the month, the Fed indicated it is willing to accommodate the trends as the economy re emerges from a pandemic-induced period of restraint as it remains focused on the level of unemployment.
President Biden got off to a quick start by signing a series of executive orders aimed at regaining control of the pandemic and re-entering the Paris agreement.
Data on infections continued to trend down and the vaccine rollout accelerated. Vaccine producers are expected to provide 600 million doses, covering the adult US population, by the end of July.
Investors are expecting Congress to approve Biden’s “Rescue Plan” of close to $1.9 trillion. In addition to the Covid relief package approved at the end of December, it could mean overall stimulus for the economy totals around 13% of GDP in 2021. This is on top of the massive stimulus already delivered earlier last year, which helped households to save almost 8% of GDP more than they normally would. The additional stimulus cheques and unemployment benefits could lead to a significant acceleration in consumption, particularly once restrictions are lifted. However, the huge size of the fiscal package—when combined with ample liquidity in the system, possible post-pandemic bottlenecks in supply chains and pent-up demand—could also lift inflation.
Nevertheless, Treasury Secretary, and former Federal Reserve (Fed) Governor, Janet Yellen reiterated her support for the fiscal plan, showing more concern about unemployment than inflation.
January inflation registered a moderate 0.3% month-on-month (m/m) increase, driven by energy, but core inflation remained unchanged (up 1.4% year on year). Inflation is expected to rise in mid-2021 as lockdown-related base effects will drive the annual rate higher. However, the rebound is likely to be short-lived, as highlighted by Fed President Powell, with headline inflation dropping again by early 2022.
With markets already pricing in higher inflation expectations, the US yield curve in steepening. The 10-year Treasury yield ended the month at 1.42% (up from 0.91% at the start of the year). To mitigate concerns over rising yields, the Fed kept its guidance on asset purchases unchanged in its January meeting minutes, and declared that the economy remains “far from the goals” of substantial progress on employment and inflation, stressing that it would be “some time” before it considers tapering asset purchases.
Economic momentum is solid. US retail sales (ex-autos) bounced 5.9% m/m in January, boosted by the $600 stimulus cheques that were approved just before Christmas. Manufacturing and services purchasing managers’ indices (PMIs) jumped to 58.5 and 58.9 respectively, indicating a more favourable outlook, particularly for the services sector, which has been hardest hit by lockdowns. But labour market statistics are still disappointing, with high levels of jobless claims and subdued consumer sentiment.
The S&P 500 index closed the month with a 2.8% return. Value sectors, such as energy and financial services outperformed thanks to expectations of a rapid return to a post-pandemic normality, which lifted oil prices and steepened yield curves.
In the UK, the vaccination campaign is progressing remarkably well and has already reached 20 million people. Boris Johnson recently announced a target of achieving full coverage of the adult population by July and announced a gradual reopening, starting with schools, in March.
From a macroeconomic standpoint, retail sales (ex-fuel) fell sharply in January (-8.2% m/m) as a result of the lockdown. But flash PMIs surprised to the upside, indicating improving sentiment, with manufacturing and services moving up to 54.9 and 49.7 respectively.
The FTSE All-Share Index closed up 2% despite a stronger pound, on the back of the strong vaccination progress.
A small rise in new cases in China had led to some mobility restrictions during the New Lunar Year holidays that could moderate but not derail the strong V-shaped recovery. Markets were more concerned about the prospect of a dampening of stimulus measures to curb the risk from rising house prices. The People’s Bank of China confirmed its intention to maintain a prudent but flexible policy stance.
The renminbi continued its appreciation, supported by the increased growth gap between China and the rest of the world, and greater global interest in Chinese assets.
The European Commission (EC) President Ursula von der Leyen admitted delays in the rollout of the vaccines. The goal is now to vaccinate 70% of the adult population by summer. In the meantime, many countries are extending selective lockdowns.
In Italy, the formation of a new government led by Mario Draghi, the former European Central Bank president, was approved by a large majority in parliament, avoiding the undesirable scenario of snap elections during a pandemic. The priorities of the new government are to address critical near-term issues, such as an effective vaccination plan, new support to prevent Covid-19 related layoffs, and an effective plan to use the resources of the European Recovery Fund. The market reaction was favourable, with the spread between 10-year Italian and 10-year German government bond yields falling to 1%. Draghi is still remembered fondly by markets for his role in resolving the eurozone sovereign debt crisis with his “whatever it takes” speech in 2012. He is viewed as a highly competent, pro-euro, “hand at the wheel” who can steer the Italian government through the pandemic.
The European Parliament has given the go ahead for the Recovery and Resiliency Plan. After ratification, individual countries will start to submit projects to the EC for final approval. A rapid implementation could redraw investors’ attention to Europe, after years of net equity outflows.
From a macroeconomic standpoint, the February flash Manufacturing PMI strengthened to 57.7 (+2.9 pts) while the services index remained weak at 44.7. Consumer confidence improved only marginally though, confirming lingering uncertainty about the outlook.
Global markets kicked off February on a rather strong footing, but higher inflation expectations and rising long dated yields soon spooked investors, especially interest rate sensitive assets such as long duration stocks and global bonds.
The effect of rising US long bond yields was felt by the local bond market in the second half of the month, as investors shrugged off the positive Budget which the market had initially reacted positively to. Ultimately, the ALBI ended the month flat which was a rather good outcome considering that sovereign bonds had their worst month in the last 35 years. Foreigners were net sellers of SA bonds over this period, but one shouldn’t read too much into this figure considering the flight of capital to the US. This was also evident in the Rand/$ which weakened from a high of 14.4 intra month to close above R15, losing 0.3% against the greenback in the month.
After a prolonged period of local risk assets underperforming their developed and emerging market counterparts, the local market appears to have found a level of stability and a renewed level of optimism. While this trend has gradually turned over the course of the last few months, the bifurcation was most noticeable in February where SA equities and property bucked the trend and outperformed most major developed and emerging markets in a rising yield environment. The biggest contributor to the ALSI’s rise of 5.9% was the resource and telecommunication sectors which were up 11.5% and 10.5% respectively. What was most encouraging was that returns from most of the sub-sectors were also positive, highlighting the breadth of the gains in the local market.
Listed property also had a decent month for a change, delivering a stellar 8.6% as investors are starting to price in a more normal operating environment as Covid restrictions are eased. Of the 21 stocks in the SA listed property index, only 3 were negative in February.
Domestically, the 2021/2022 Budget delivered in February drew plenty of attention and rightly so, the trajectory of the fiscus is critical to the return potential of SA bonds which throughout couple of years have offered equity like returns but with increasing risk. Furthermore, after many years of kicking the proverbial can down the road, Treasury have reached a point where a passive approach of debt consolidation is simply unsustainable and further inaction would almost certainly lead to more ratings downgrades and higher borrowing costs which the country simply cannot afford.
It was a welcome surprise then to see Treasury hold the line in consolidating the bloated public sector wage bill which was cut by a further R81bn compared to last year. The 2021 Budget notes that the consolidated compensation budget is now projected to grow just 2.1% this year and 1.2% pa over the medium term via a combination of no cost-of-living adjustment to wages (essentially a pay freeze) and some reliance on early retirement and natural attrition to reduce headcount. On the revenue side, SA has been fortunate to benefit from better-than-expected economic growth (mostly thanks to robust commodity prices), and the overshoot of about R100bn gave Treasury capacity to cancel its planned tax hikes and reduce bond issuance. We are by no means out of the woods yet and further support for failing SOE’s like SAA suggests that Treasury may not be serious enough. For now, we should give Treasury the benefit of the doubt because they at least seem to be making the most of the improvement in exogenous factors.
Inflation figures for January came in a little better than expected, increasing to 3.2% YoY from 3.1% last month. The slightly better inflation outcome is mainly attributable to a slowdown in food inflation (to 5.6% from 6.2%) despite global food prices recording their highest monthly gain since the end of 2011. Concerns of higher inflation later in the year as fuel and transport prices are expected higher, as are excise duties and electricity prices. Economist are penciling an inflation print of 4.5% or higher for the second half of 2021.
Economic growth figures available for Q4 2020 surprised to the upside, the main contributors were Manufacturing, Retail Sales and Transport, while Mining, Wholesale Trade and Electricity & Gas all contracted QoQ.
Expectations for an imminent exit from the pandemic thanks to a rapid vaccination rollout continue to be a positive catalyst for markets. However, new and unpredictable mutations of the virus are a potential risk. The risk of a return of inflation that could materialise in mid-2021 is fuelling a trend of rising yields. Value versus growth rotations could continue as we progress towards the end of the pandemic and are supported by rising commodity prices and rising yields, which particularly benefit financials. The base case is that inflation will likely surprise on the upside and growth stocks could struggle but should normalise and get second wind in the second half of the year as the base effects of last year wear off and the government fiscal package has to hand over to the consumer for 2022 where little to no fiscal stimulus is expected . The hope is lower unemployment will keep the economy’s growth path intact as consumers should spend more. The key is that the US output gap which is still relatively wide should absorb a lot of the increased demand along with years of improved productively from tech advancements. That rules out in our mind a 70s type of runaway inflation scenario but does mean will be volatile for next couple months as oil prices continue to rise and supply constraints drive prices higher.
Fund and Portfolios Overview
Some of the consolidation that began in January persisted into February with growth names coming under pressure as the US 10YR moved higher. Quality/Growth equity despite having delivered impressive top and bottom-line growth for Q4 suffered and indiscriminately so, with value supported by retail/reddit traders moving higher irrespective of whether the fundamentals made sense or not. A number of hedge funds that were caught in a short squeeze during the “gamestop” saga where also forced to sell down their quality long positions which added further fuel to the rotation . This meant that the equity book for the Iza portfolios came under pressure, in particular Scottish Mortgage which has been a bastion of strong performance for months now and so not unexpected that some profit taking was on the cards as rates backed up. This fund holds a number of positions that look to be beneficiaries from high growth long into the future. This weakness and volatility for the portfolio is not unexpected after a year like 2020 and particularly around inflection points for rates, but we don’t believe it will be long lasting. Given the longer-term investment horizon its never beneficial to try time entry and exit round these bouts of volatility as this can be hugely detrimental to long term performance. The rebound post periods of weakness can be vicious and while rates are a key factor to consider and there is room for them to move higher we don’t expect this to become disorderly. Further it does not mean that just because the US 10 YR is moving higher that our equity managers cannot still deliver market beating returns as seen in the below analysis. We looked at each of the periods when the US 10YR increased going back to 1990 and as you can see these funds, and in particular Scottish Mortgage managed to deliver strong returns despite the increase in rates. In fact, keeping risk on during these periods was vitally important as on average the S&P 500 delivered an annualised return of 15%