Global Market Overview
Whilst first-quarter global growth will be at best sluggish, reflecting the recent wave of the virus in the US and Europe, market participants are looking ahead to a reopening of the global economy from the second quarter and beyond. This should see growth peak at its strongest level for twenty years, accompanied by the strongest growth in corporate profits since 2009.
Financial markets like certainty and, if we exclude the prospect that the effectiveness of the vaccines proves much lower than anticipated, these expectations are highly likely to be realised. There is significant pent-up demand in the global economy once restrictions to free movement are progressively eased – and fiscal and monetary stimuli continue to work their way through the economy.
Reflecting this supportive background, equities began 2021 on a strong footing, building upon the gains of November and December. During the month, global equities were as much as 6% higher, with gains led by the Asia (including Japan) and the Emerging Market world more broadly. These regions have, in general, benefitted from a relatively-better growth dynamic reflecting a more successful approach to managing the pandemic, the trend of Dollar weakness, supportive global liquidity, and more favourable valuations.
However, as we headed toward the latter stages of January the market environment changed markedly. We witnessed several retail-driven short squeezes in stocks on the Robinhood platform, as retail investors were encouraged by online message boards to buy equities where short interest was at high levels.
Whilst we saw outsized gains in names such as GameStop (at one point during the month it had rallied 2,350%!) a number of hedge funds who were short these stocks were forced to cover and also liquidate profitable positions in a range of other more liquid large cap stocks to offset losses.
More broadly, with strong liquidity driven gains in equities over recent months, market participants have become concerned that key markets and sectors within them may be entering bubble territory and the sharp month-end correction could prove a precursor to a deeper market selloff.
Elsewhere, some commentators have argued that high levels of retail participation in the stock market is symptomatic of the type of late cycle bubble we saw in technology stocks in the late 1990’s.
However, whilst there are similarities there are also differences. In the West, a large majority of employed workers are at home, and with normal activities significantly curtailed the savings rate has risen as high as the mid-teens. In the US in particular, this significant rise in involuntary savings has supported a boom in retail equity market participation which has caught many traditional investors off guard and has amplified market volatility.
Central banks have lowered real interest rates to record low levels and continue to flood the financial system with excess liquidity, which remain a tailwind for risk assets. In addition, low real and nominal bond yields help offset high equity valuations via supporting a relatively generous equity earnings yield over bonds.
Against this background, aside from an ultimately unsuccessful vaccine rollout, arguably the biggest threat to equities would be a spike higher in interest rates on fears that resurgent demand boosted by policy stimulus could see a substantial increase in inflation. Whilst we expect a modest pickup in inflation this year, reflecting base effects and stronger growth, we expect central banks will look through this dynamic, and will be keen to avoid removing policy accommodation before the economy is well on the way to a more self-sustaining recovery.
All told, this suggests that the key central banks will allow their respective economies to run “hot” for a little while before signalling less stimulatory policies. This easy money, strong growth and rising inflation dynamic tends to be a tailwind for equities, so we remain constructive on risk assets for the time being. However, as far as financial markets are concerned, it’s often better to travel than to arrive, so by the time restrictions are eased meaningfully and growth picks up markedly we would expect to have seen most of this year’s equity market gains.
The macro data is painting a mixed picture of the US economy. January’s flash-purchasing managers’ indices (PMIs) continued to point to expanding economic activity, with the manufacturing index at 59.1 and services at 57.5. The housing market is another area of strength, with construction starts rising in December at the fastest pace since 2006 and accelerating home prices. Property values gained 9.1% from a year earlier, which was the biggest jump since the spring of 2014. On the downside, Covid is taking its toll on the labour market again. December was the first month since April that the US economy shed workers. Consumer confidence stabilised but is still significantly below pre-Covid levels. The Democratic victory in the two Senate races in Georgia handed them control over Congress and should boost US growth in 2021. Just one week after victory, the new administration proposed a USD 1.9 trillion “American Rescue Plan”. The plan is on top of the bi-partisan USD 900 billion stimulus that was agreed in late December.
Even if the plan gets slimmed down because of the narrow Democratic majority in the Senate, the macroeconomic impact is dramatic as the overall stimulus bill for 2021 is likely to be worth close to 10% of GDP. The high amount of transfers to private households and fast implementation could lead to a significant acceleration in growth in the event of a successful vaccination campaign. For bond markets, increased expectations of government spending are putting upward pressure on long-dated US Treasury yields and for equities, an environment of moderately higher government bond yields and improving near-term growth prospects should provide support for cyclical sectors and small caps on a relative basis.
The implications for the US dollar are less clear. Higher bond yields and stronger growth prospects relative to the rest of the world should in theory provide support for the greenback, although this may be counteracted by the impact of higher consumer spending on the US current account. The Democratic majority in the Senate also increases President Biden’s opportunity to implement climate policy as part of broader fiscal measures to support growth and speed up the energy transition of the country. This backdrop should generate opportunities for investors in several asset classes, including real assets and global renewables, all of which have rallied over the last couple of weeks.
After a relatively resilient fourth quarter, growth dynamics in the UK deteriorated in January. The lockdown is taking its toll on economic sentiment. The Flash Composite PMI fell sharply from 50.4 to 40.6 in January, indicating a significant hit to the economy from the latest restrictions. Nevertheless, the vaccine rollout has been relatively successful. More than 13% of the population have already received a dose vs. an average of below 3% on the continent.
The excitement in the equity markets about the last minute Brexit deal was rather short lived, which confirmed our view that Brexit is only one piece of the puzzle for UK equities. Of greater consequence is likely to be the relative performance of the UK with regards to the handling of the virus and reopening of the economy.
Supported by a recovery in demand in both domestic and external markets, China’s economic growth kept accelerating in the fourth quarter of 2020. Real GDP rose by 6.5% year-over-year, back to the trend growth rate. China will likely be the only large economy to achieve positive GDP growth in 2020. More importantly, the recent growth is broader in comparison to previous quarters. As domestic activity has resumed, the hard-hit service sector has caught up with industrial sectors, which were the early leaders of the recovery. In December, the Caixin China Services PMI, at 56.3, was above the 53 reading of the manufacturing index, suggesting that the major growth driver has shifted to demand from consumers and private enterprises.
Trade normalisation and strong demand for health care equipment and work-from-home technology has also supported growth in China. Chinese manufacturers have been able to gain market share as international competitors have been hampered by lockdowns and supply chain disruptions. As a result, Chinese industrial production increased by 7.3% year-on-year in December, and exports rose 18.1% year-on-year, leading to a record trade surplus for the month.
China’s strong economic momentum is likely to lead to a broad-based recovery in corporate earnings. Nevertheless, subdued stimulus may put a cap on any further valuation upside in equities, which have already run up to a price-to-earning ratio of 16.8x in the past 12 months. Additionally, political risk might increase if China’s recent trade success comes under scrutiny from the new Biden administration.
Sentiment and growth in the eurozone took a turn for the worse in January. The flash-composite PMI for the region declined to 47.5 and consumer confidence retreated. The weakness in activity reflects the effect of the ongoing pandemic. New and more infectious virus strains first discovered in the UK, South Africa and Brazil are magnifying the challenge for policymakers, who responded with more stringent lockdown and social distancing measures. As a consequence, a double-dip recession has become more likely. Slow vaccine rollout in the large economies of the eurozone is increasing the risk of a delay in the economic recovery.
Eurozone equities reacted with caution to these developments. An escalation of the political crisis in Italy that ended with the resignation of Prime Minister Conte wasn’t helpful for market sentiment either. Due to their higher cyclicality, eurozone equities continue to be closely linked to the trajectory of the pandemic.
Local markets continued their strong run from where they ended the last quarter, enjoying the increase in risk appetite for emerging markets which stand to benefit from benefitting from a weakening US$ and robust commodity prices, as well as a re-opening of global economy as the vaccine roll-out gathers momentum. The JSE/All Share Index ended the month 5.2% higher, with most of the gains attributable to a stellar run from market heavy weights like Naspers, BHP and Richemont who delivered 15.2%, 7.6% and 6.7% respectively. The local currency weakened by 3.2% against the US$ which aided the diversified miners and rand hedge component of the index.
After ending the year on a high note, the domestic constituents of the JSE came under pressure, with financials and property stocks falling 3.1% and 3.2% respectively. This was somewhat of a theme globally with many of the US banks exhibiting surprising selloffs despite reporting better than expected Q4 earnings. We have always pointed to the fact that there is a high correlation between global banks and SA banks and the performance of these stocks in January is testament to this correlation.
It was a relatively quiet month in fixed income markets as the MPC kept rates on hold, as was largely expected. Inflation remained benign at 3.1% and the annual average sitting at the lowest it has been in 16 years. While consumers will be happy with low rates and subdued inflation, the sad reality is that these are largely a function of the weak growth locally.
The broader upbeat sentiment was supportive for local bonds which today still offer some of the highest real yields in the world. The FTSE/JSE All Bond Index gained 0.8% for the month.
From a multi-asset perspective, the last 6 months have proved to be quite lucrative for local growth investors after years of lethargic returns. This may come as a surprise considering the state of the local and global economy thanks to the Covid-19 pandemic, but it talks the magnitude of stimulus in the global financial system that should not be ignored. Most interestingly, this comes at a time where interest-bearing and money market ASISA categories have attracted significant inflows (approx. R150bn in 12 months) just as local rates have reached record lows, while the growth orientated categories have seen further outflows (approximately R100bn) in the last year. The recent strong
returns have been especially true for value orientated fund managers who have benefited from the global style rotation that started in Q3 2019.
Unfortunately, the improved performance in SA assets comes at a time when the local economy has gone through another weak phase, thanks to re-introduction of more stringent lockdown measures which will have no doubt affected consumer discretionary spending over the holiday season. While the second wave has increased the downside risk for local growth, economists still expect growth of approximately 3% for 2021 (compared to an estimated contraction of 7.1% in 2020).
However, SA’s trend growth emerging from the pandemic in the coming years will be critical, especially given the ever-weakening financial position and lack of implementation of any strategic growth initiatives. Small wins such as the plan to freeze the public sector wage bill in nominal terms, suggests there is hope but time is running out. All eyes will be on Tito Mboweni as he delivers the 2021/2022 budget towards the end of February.
Looking ahead, South Africa is well positioned to benefit from its position as a key commodity producer, especially in the PGM segment of the market. While commodities account for less of GDP than they once did, there is still a high correlation between the returns of local asset classes and the global commodity cycle. The government has an almost impossible task of reigniting the economy with their hands tied (by a weak fiscus) but they may be lucky that the cycle may have turned just when they needed it most. Whilst the long term prospects for SA depend on a sustained level of higher growth, the near term prospects depend on the global economic recovery, and in particular the strength of important trading partners like China and Europe.
The news flow in January reminded us of two important things. First, governments and central banks are fully committed to support the economy with massive fiscal stimulus and very easy financing conditions. The two stimulus plans in the US and ongoing supportive comments from the G4 central banks perfectly fit this narrative and give investors reason for optimism. Second, January showed us that Covid remains a risk. New highly infectious strains and the risk that existing vaccines might be less effective against some mutations remind investors that the bridge to the post-Covid world might be longer than we all wish for, at least in some parts of the world. After a strong run in risky assets followed by the recent pause for breath, staying cautiously optimistic but with a balanced portfolio seems sensible during this still challenging period of the pandemic. It is hard to tell at what point the bear market in bonds will pick up strength, creating downward pressure on high duration assets. Nevertheless, entering the second half of the year, market conditions could change, and upward pressure on bond yields could intensify. The speed of vaccinations in the U.S. has been impressive, having accelerated to 1.5 million doses per day. At this rate, over 80% of the U.S. population will be inoculated by summer. In fact, the speed will likely quicken with vaccine supplies being ramped up further and the vaccination process streamlined. This could propel America back to normalcy much faster than expected, helping unleash a spending boom. If so, we see a strong possibility that 10-year bond yields test 1.5% before summer, and could even spike above that resistance level, especially if the Fed ever hints at tapering QE. At that point, the stock market could come under corrective pressure again, with high-duration stocks bearing the brunt.