In the February issue we discuss: optimistic equity investors are positioned for a successful vaccine rollout and rising US inflation is a boon for “value” markets (e.g. the UK & emerging markets).
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Despite higher levels of new COVID-19 cases prompting stricter lockdowns in many parts of the world, the MSCI All Country World equity index (ACWI) was virtually unchanged in January1. Investors’ optimism was lifted by the COVID-19 vaccine rollout, supported by ongoing stimulus and expectations of an earnings recovery. Globally, around 1% of the population have been vaccinated, at a run rate of nearly 4 million per day, albeit with the EU lagging2. The new Biden administration has promised to deliver 100 million shots to Americans in his first 100 days. Given the current pace is 1.5 million per day and rising, this seems to be an achievable ambition3. While that would only immunise around 30% of the population, it should nonetheless protect front-line workers and the most vulnerable to the virus. In turn, this should reduce hospital admissions and encourage the US authorities to lift lockdown restrictions.
In the UK, the government has made lifting lockdowns dependent on vaccinating 15 million of the top four priority groups4. Given that around 9 million people have already received their first shot, the inoculation programme is on track to meet this5. Moreover, the third lockdown is likely to have less impact on growth than previously. Unlike last spring, construction and manufacturing firms have remained open, while retailers can provide click and collect service and have had more time to adjust to provide online deliveries.
Considering the gains seen in equities since last March, there is plenty of market risk dependent on the efficacy and speed of the vaccine rollout. Mutated strains of the virus may emerge which are more resistant to current vaccines, and the population may not be inoculated fast enough to drive consumer confidence and spending up. As an insurance against this uncertainty, governments around the world have shown a willingness to take pre- emptive action to stimulate demand and protect against downside risk to the economy. For instance, following the $900 billion pandemic relief package already legislated by US Congress in December, President Biden announced the $1.9 trillion “American Rescue Plan” in January6. While not all elements of this latest fiscal package will end up in law, $1,400 stimulus cheques to qualified individuals (on top of $600 payments passed in December) and more generous unemployment benefits should pass the now Democrat-controlled Congress7.
This front-loaded boost to take-home pay increases the likelihood that consumer spending can recover quickly to boost growth. Consensus forecasts are for US real GDP to grow by 4.1% in 2021, which if realised would be the fastest growth rate for 21 years8.
It is largely because of the vaccine rollout, stimulus measures and economic recovery that analysts continue to remain upbeat about company earnings. The consensus range for MSCI ACWI Earnings Per Share annual growth has held remarkably steady at around 29% and 15% for 2021 and 2022 respectively, since the summer9. This fundamental support suggests that equities can continue to rally even during the pandemic and lockdowns.
Rising US inflation is a boon for “value” markets (e.g. the UK & emerging markets)
The direction of inflation, and particularly in the US, is likely to be an important determinant for relative equity market performance. US implied inflation (derived from the Treasury market) has swung round from 0.5% per annum over the next 10 years last March to 2.1% currently, the highest rate since late 201810. This is consistent with the Fed’s policy change last summer to encourage higher inflation.
Moreover, the macro backdrop appears a little more inflationary. Given high involuntary household savings rates from fiscal stimulus, pent-up cyclical consumer demand could absorb slack in the economy, as a result of the pandemic easing relatively quickly (see our November Investment Outlook). Structurally, the downward pressure on wages (and inflation) from the last couple of decades may be reversing too. China’s working age population started to fall in 2011, reducing the size of the global labour pool, and this could lift future wage rates11. Furthermore, manufacturers may bring more costly production closer to home to avoid COVID-related supply chain issues. If realised, this de-globalization could raise future inflation rates.
We see investment implications from higher US inflation expectations. Looking at data going back to 2009, we find that “value” orientated equity regions like the UK and emerging markets typically outperform their global peers in a rising US inflationary environment. These markets benefit from their relatively high exposure to value sectors, such as energy, materials and industrials, and low valuations.
Both the UK and emerging markets are also likely to profit from an easing in idiosyncratic risks. UK equity valuations should improve following the Free Trade Agreement in goods agreed with the EU at the end of last year, while emerging markets should gain from an expected multilateral approach by the US over trade policy under a Biden administration, compared to Donald Trump’s policy to impose ad-hoc trade tariffs on China. The UK and emerging markets fit into our “Loving Unloved Stocks” theme for 2021 – see our January Investment Outlook.
1, 2, 3, 5, 9, 10 Refinitiv/Smith & Williamson, 1 February 2021
4 Pantheon Macroeconomics, The weekly UK Economic Monitor, 18 January 2021
6,7 HSBC Global Research, US Fiscal Policy report, 20 January 2021
8 Bloomberg, 20 January 2021
11 The Inflation Outlook, Raymond James, 19 January 2021
By necessity, this briefing can only provide a short overview and it is essential to seek professional advice before applying the contents of this article. This briefing does not constitute advice nor a recommendation relating to the acquisition or disposal of investments. No responsibility can be taken for any loss arising from action taken or refrained from on the basis of this publication. Details correct at time of writing.
Please remember investment involves risk. The value of investments and the income from them can fall as well as rise and investors may not receive back the original amount invested. Past performance is not a guide to future performance.