Macro Matters September 2021

(Source: Merlea Macro Matters)

Summary

Is the global recovery peaking?  Despite the acceleration in activity over the second quarter, I continue to monitor two key areas, which could pose downside risks to the global outlook.  First, there has been a rapid pick up in the number of infections globally, particularly of the Delta variant, and second, high frequency data are easing already. Rising caseloads of the Delta variant is posing a downside risk to growth, particularly for countries with low vaccination rates.  Initial data suggest that despite a sharp rise in the number of cases in the UK, the case fatality rate remains low (LHS chart). The case fatality rate also remains low in regions such as North America and Europe, where vaccination rates are higher than their emerging market counterparts. However, in Asia, South America, and Africa, where vaccination rates remain low, the mortality rate remains elevated and if economies – predominantly emerging markets (EMs) – suffer from a lack of access to vaccines, they will remain exposed to downside risks to growth.

Higher Vaccinations Means Lower Mortality / Global – Case Fatality Rate for UK & Regions (RHC)


Source: Bloomberg, Citi, Fitch Solutions

High frequency data suggests that momentum is starting to ease. It seems that the global PMI index may have peaked already, while at the same time, the Citi Surprise index has eased significantly, which suggests that incoming data are no longer beating expectations to the degree that they were several weeks ago.

While slower growth is to be expected over the coming months as base effects wear off, shortages and supply chain challenges are also a factor behind the weakening of momentum, which could potentially serve to cap growth rates going forward. For example, in the US, real GDP growth came in at 6.5% q-o-q annualised in Q221, which was well below the Bloomberg consensus estimate of 8.5%, and part of the shortfall can be attributed to supply chain issues capping private investment.

Global – PMI Indices (LHC) / Citi Surprise Index

Source: Bloomberg, Citi, Fitch Solutions

According to the July manufacturing PMI survey from the US, all segments have been impacted by near record-long raw-material lead times, continued shortages of critical basic materials, rising commodities prices and difficulties in transporting products. Moreover, latest survey data from IHS Markit show that supply chain delays and capacity constraints across the global economy worsened in July, which could ultimately serve to cap economic momentum over the coming months, while inflation expectations remain benign, persistent shortages of both labour and materials considering strong demand pressures as economies open, could see inflation remain stickier to the upside for longer than we currently expect. In turn, this could put pressure on policymakers to act to rein in price pressures. Already, several emerging market central banks have raised interest rates in response to above-target inflation, while the Spanish government has called on the EU to back measures to limit surging electricity prices.

Australia

The economic recovery in Australia has been stronger than was earlier expected. The recent outbreaks of the virus are, however, interrupting the recovery and GDP is expected to decline in the September quarter. Prior to the current virus outbreaks, the Australian economy had considerable momentum and it is still expected to grow strongly again next year. The economy is benefiting from significant additional policy support and the vaccination program will also assist with the recovery. However, the current outbreaks of the Delta variant across Australia, and the resulting lockdowns, have introduced an elevated degree of uncertainty to the outlook for the second half of this year. Activity will contract in the September quarter and some job losses are expected. While the Australian economy is forecast to rebound from this setback as restrictions ease, as it has from previous lockdowns, the Delta strain is likely to require a more thoughtful reopening of the economy in affected areas than in the past. The Australian economy entered this challenging period in a strong position and fiscal policy is directly supporting households and businesses in the affected areas.

Bonds

For rest of 2021 bonds certainly offer lower yields than we’ve seen in recent decades, yields have been on a declining trend since the 1980s. Yet unsurprisingly the markets are being consistent, stock valuations don’t look too enticing either. Asset prices have been bid up as the broader markets see low and stable inflation over the coming years.  If bond markets are taken at their word, the world post-pandemic will be defined by stagflation, a scenario that appears at odds with the bounce back indicated by robust economic data and record-high equities.

Bond yields, nominal as well as “real” ones, which strip out expected inflation, have fallen in the Australia, United States and the Euro area. Signalling weak growth, and years of ultra-loose monetary policy.

While real 10-year yields on U.S. inflation-protected securities (TIPS) have halved since late March to a record low below -1.20%, a measure of future inflation, known as the breakeven rate, hasn’t fallen far from this year’s highs. The 10-year U.S. breakeven rate, the inflation level where returns on nominal bonds and TIPS would be equal, is now at 2.35%. With inflation data surprising to the upside, the risk is that inflation could be less transitory than central banks believe. The University of Michigan’s latest monthly survey shows consumers also see inflation at 2.8% in five years’ time.

Perhaps the bond markets believe the US Federal Reserve when it suggests that current inflationary pressures are transitory and that the Fed can hold policy interest rates down for an extended period. If so, growth – bolstered by pent-up savings and the additional government spending currently being negotiated in Congress – should be reasonable, and inflation should remain around the Fed’s target. The breakeven inflation rate also seems to be pointing to this scenario.  But that doesn’t explain why the ten-year Treasury rate is so low, suggesting negative real rates over the next decade.

Fed Chair Jerome Powell’s announcement last month that the economy had made progress toward the point where the Fed might end its $120 billion monthly bond-buying program was good news. Phasing out quantitative easing (QE) is the first step toward monetary-policy normalisation, which itself is necessary to alleviate the pressure on asset managers to produce impossible returns in a low-yield environment. But the beginning of the end of QE would not please everyone.

While government debt has soared, government interest payments remain low, and have even shrunk as a share of GDP in some countries over the last two decades. As such, many economists are not worried that government debt in advanced economies is approaching its post-World War II high. But what if interest rates start moving up as inflation takes hold? If government debt is around 125% of GDP, every percentage-point increase in interest rates translates into a 1.25 percentage-point increase in the annual fiscal deficit as a share of GDP. With interest rates normally rising by a few percentage points over the course of a business cycle, government debt can quickly become stressful.

Listed Property

REITs are well positioned to take advantage of a growing economy because they entered the crisis with historically strong balance sheets and access to credit and liquidity.  Nevertheless, uncertainties remain. Most critically, how will the future of office use evolve as firms return to the office and experiment with hybrid and work from home arrangements. The future AREIT index may look more like its US counterpart, where commercial property investors can add healthcare properties, life science and government buildings and even mobile phone towers to their portfolios.  AREIT performance is directly linked to the Australian economy. On that score, the ongoing recovery will be boosted by six factors:

  • Firstly, a return to the office will assist struggling CBD retail as foot traffic rises.
  • Secondly, price growth in residential property and ongoing construction will boost retail, especially DIY and homeware categories and improving consumer confidence. Consumers’ willingness to spend, a key plank in the path for a return to pre-Covid life, should gather pace.
  • Third, the vaccine roll-out will further lift business and consumer confidence.
  • Fourth, the return of international tourism, potentially exceeding prior levels (revenge travel as consumers look to catch-up), should have a similar impact.
  • Fifth, as will the return of international students, with residential and retail property clearly benefiting. Overseas students can also help us address current labour shortages.
  • Sixth, the return of immigration will be a major economic driver and, as with foreign students, residential real estate will be a major beneficiary, with flow on benefits for office/retail and other real estate sectors.

The major risks to the AREIT sector concern all those factors that may apprehend the economic recovery. Inflationary pressures that may result in higher interest rates, damaging the wealth effect, the continued slow pace of vaccine rollout and more damaging mutations should all be considered. While inflation has become a growing concern across financial markets, it could see more investors turn to commercial real estate which has leases that have inflation linked or fixed rental escalations providing a level of protection that other asset classes cannot provide.

Knight Frank research reports while the timing of the recovery remains uncertain on the basis of a solid economic recovery during 2021 effective rental growth is expected to rebound from 2022 as leasing markets recover with a lag, although face rent performance will be subdued as incentives adjust back down .Sydney, Melbourne, Brisbane and Perth are all expected to see sizable increases in effective rents between 2022-2025 with Perth predicting to see the strongest rise over the period reflecting the relative favourable economic outlook.

Australian Equities

The past financial year has been extraordinary — not just for all of us living through the pandemic, but also for Australian companies. Some have thrived despite, or in some cases because of, the pandemic and the resulting restrictions. Others have suffered but have begun their recovery. And some, such as airlines and travel agents, remain highly affected. The Australian share market rose by more than 20 per cent over the year to June 30 and it continues to hit new highs. As a result, the ASX is no longer unambiguously cheap, so the easy gains are likely behind us.

Australian export industries had become increasingly vulnerable to potential disruptions of market access to China due to rising concentration risk to that single market. This had become well recognised as a key risk by Australian policymakers and industry leaders in recent years although little concrete policy action was taken by companies to reduce their vulnerability to such trade concentration risk.

The reasons for this view are:

  • Firstly, risks around the Australian economy continues as the local and global COVID-19 situation develops which will dictate lockdowns, and the timing of opening borders with other trading nations. The strength of the Australian economy has weakened significantly in the face of lockdowns in all mainland capital cities. Most economists are expecting a decline in economic activity for the September quarter and economic growth forecasts have declined from 4.5% for 2021 down to around 4%.
  • Secondly, the RBA also announced that it would start the slight tapering off its quantitative easing (QE) program, with the bank reducing the number of government bonds being purchased from $5b to $4b per week after September and then continuing there on out until mid-November at the earliest.
  • Third, China’s threats around tariffs and reducing purchase of Iron Ore appear to be increasing. The increased rhetoric around the cause of COVID being an outbreak from a Wuhan lab won’t help.
  • Fourth, equity markets are also looking very expensive, although investors are likely to continue accepting risk whilst defensive assets appear to yield below inflation expectations. While there is a risk of a short-term correction in shares, returns are likely to slow from the pace of the last year, overall returns from well diversified portfolios are still likely to be reasonable over the next 12 months.

Looking at Australia there are reasons to argue that the stock market will prove more resilient, however we must always be ready to respond, as needed, to any significant sell-off, as we did during the pandemic lows last year. This would likely open several select buying opportunities. It is worth noting that some corners of the market have already had a hefty ‘correction’ – BHP and Rio Tinto for example are down more than 20% from their highs. Sectors never generally move in tandem, and the same will likely prove true if the market runs higher or corrects significantly. The key, in our view, is to be prepared for any eventuality. As was the case last year, we would likely use a broader market pullback to recommend existing stocks as buys to those without exposure, while also introducing new companies to the client base. If, on the other hand, the markets push higher, we will also be vigilant of the need to take profits if valuations have become over-extended.

Global markets

Shipping disruption and the impact on inflation

One of the factors that have contributed to an acceleration in inflation in major economies in recent months has been a sharp increase in the cost of transporting containers. The cost of shipping a container from East Asia to the West Coast of the United States has increased by more than 50% since April. The cost of shipping a container from East Asia to Europe has increased by roughly 75% over the same period. The Baltic Dry Index (BDI), which is the most popular measure of the cost of shipping nonliquid bulk commodities, such as coal, wheat, and iron ore, has hit the highest level since June 2010, although it remains far below the peak reached prior to the 2008-09 global financial crisis. The increase began early this year as the global economy appeared to be on a path toward recovery.

Shipping costs from China to Europe have risen steadily since late 2020, while costs from China to North America jumped sharply in recent weeks.

The increase in recent days likely reflects the impact of the closure of one of China’s largest port facilities, a terminal at Ningbo-Zhoushan. This closure was in response to the rising Delta outbreak. As companies have attempted to shift transport logistics, that closure has led to congestion and delays at other ports, such as that of Shanghai, one of the worlds busiest. The closure has affected both exports and imports. Moreover, September is generally the peak month for Chinese exports. That is when goods are shipped for the holiday season in the United States, Europe, and elsewhere. Even with the port opens it will likely take several weeks to work through the accumulated congestion. Thus, the BDI is likely to remain elevated for the foreseeable future. Meanwhile, shares in shipping companies have increased sharply.

America

U.S. business activity growth slowed for a third straight month in August as capacity constraints, supply shortages and the rapidly spreading Delta variant of the coronavirus weaken the momentum of the rebound from last year’s pandemic-induced recession. I think there is a good chance that Covid 19 peaks in coming weeks in the US with Sunday achieving twice the average daily rate in July in vaccinations. Around 60% of the US population has received at least one shot, with circa 51% now fully vaccinated. Dr Fauci said the US is preparing to start distributing booster shots, when necessary.

That said, consumer spending may weaken from a loss of confidence amid record high home and car prices and worries about job security just as a resurgence in new cases makes consumers more cautious in venturing out freely. A weekly consumer sentiment tracker from Ipsos-Forbes Advisor experienced a sharp decline in the past month, decreasing to 54.8 for the week ended Aug. 5, from 61.9 in the first week of July. Consumers surveyed expressed concerns over high car prices and less affordable homes. A preliminary University of Michigan Consumer Sentiment Index also revealed a huge August decline in consumer sentiment, hitting a 10-year low of 70.2. The uptrend in confidence with vaccination, government checks, and the spring reopening has faded amid the resurgence of the virus, and with it, various restrictions (including mask mandates).

Despite risks from the new wave of infections, we saw further improvement in the labour market in the past month. Initial jobless claims declined for three consecutive weeks.  The US markets have grown more comfortable that the Federal Reserve would not change accommodative monetary policy any time soon. With the markets increasingly confident that the QE program and bond buying taper may now not get underway until 2023, expectations for the reflation trade have lifted along with an improving outlook for a recovery in commodity prices.

All in all, the rising headwinds from the delta variant, resumed mask requirements and other potential restrictions, China closing one of its major ports, along with continued inventory shortages/supply chain disruptions, and rising commodity prices are threatening growth momentum around the world.

Europe

The euro zone economy lost some momentum in August but is still on track for solid growth in the third quarter of this year. The latest business activity data come as many consumers enjoy the lifting of Covid-related restrictions, which has boosted the economic recovery in the wake of the pandemic. Growth estimates last month showed that the euro area had bounced back from a technical recession. This data release is important as the European Central Bank is due to meet next month and some of its members are pushing for talks on reducing some of the ongoing stimulus.

There are, however, some concerns about supply chain issues and higher inflation. The concern is that the Europe area is seeing some upward movement on wage growth because of the job market gain, which could feed through to higher inflation, and supply delays from Asia in particular look likely to persist for some time to come. As a result, momentum slowed more in manufacturing than in services. The former hit a six-month low in August, whereas services fell to a two-month low.

Prospects for European stocks are improving as a smooth vaccine rollout allows governments to lift lockdown measures. European stocks should also benefit from what we expect will be an upward move in real bond yields.That’s because European equity indices contain a greater proportion of value stocks, such as financials, which tend to outperform when real rates rise.

United Kingdom

Britain’s economy grew for a fifth month in June as the reopening of indoor hospitality and visits by patients to their GPs helped boost national output by 1%, official data has shown.  So far, the UK data look promising in two respects. First, vaccines seem to have significantly reduced the health risks from the virus. Second, the UK’s GDP estimate for May shows that activity has rebounded with the easing of restrictions despite the government’s decision to delay the full lifting of restrictions by four weeks to 19 July. Like its peers, Britain has faced steep inflationary pressures as supply chains disrupted by the pandemic and increased demand have led to price rises.

Inflation was expected to average 2.2% this quarter and peak at 2.7% next quarter. However, that upswing is likely to be transitory and is driven by the pandemic-induced low base of last year. There is a risk, however, that inflation strength will prove more persistent, which may put more pressure on the BoE to tighten policy. BoE interest rate-setter Michael Saunders said the central bank could decide to stop its current programme of government bond purchases early due to an unexpectedly sharp rise in inflation.  The bank of England is not expected to increase borrowing costs from their record low of 0.10% until 2023.  There were hopes U.K. shares would stage a storming comeback this year, lifted by a Brexit trade deal and a strong recovery from the COVID pandemic.

Despite this, the equity market continues to underperform its counterparts. UK stocks currently trade at a 33 per cent discount to world equities as measured by the MSCI All-Country World Index, the widest since 1992 when Britain was forced to withdraw sterling from the European Exchange Rate Mechanism. I think the discount will begin to fade away in the coming months.

UK economy is expected to rebound to post growth of some 7 per cent this year after suffering its biggest contraction in more than 300 years of almost 10 per cent in 2020.

Japan

If it were not for the fact that Japan’s confirmed daily Covid-19 case count has now exceeded 20,000, the highest since this pandemic began, we would have found Japanese GDP figures more uplifting. Growth recorded for the second quarter was modest by the standards of some other economies – equivalent to 1.3% at an annualised rate. We have seen far stronger growth elsewhere – the US for example, where growth was recorded at a 6.5% annualised rate in the same quarter.

But there was some more encouragement from the nature of Japan’s latest growth release. As the chart above shows, most of the strength came from domestic demand components, such as private consumer spending, and business investment. We are more encouraged to see this rather than growth in government spending or inventories because it is more likely that these can be repeated in the coming quarters than one-off policy-related boosts.  Likewise, the sizeable drag from net exports in the second quarter owes a lot to the recovery in domestic demand, sucking in imports which are a drag on the GDP figures. Assuming that this is less glaring next quarter, even if domestic demand is a little softer too, we may see this overall drag subside. And inventories, which also dragged a little this quarter, may start to be rebuilt next.

Equity markets in Japan have been as fears of the COVID19 variant intensified globally, the infection situation in Japan worsened, and the central government was expected to declare the fourth state of emergency for Tokyo, which weighed one equity prices in early July. Although Japanese companies released generally favourable earnings results, no sign of improvement was seen in the infection situation in Tokyo and elsewhere, and later in the month, concerns grew that the Chinese government would tighten regulation on Chinese companies. All this led to a softening of equity prices.

In my view, whether the infection situation of COVID19 will improve. Japan, vaccination progress, and the trend in earnings results of Japanese companies will be key factors. I expect the equity markets to remain lacklustre until the infection situation improves. On the other hand, with national elections scheduled in the fall, the government is expected to send out more positive news from later this month, such as stimulus packages and partial lifting of restrictions on behaviour/banned activities after the vaccination campaign reached more of the population, and we will need to keep a close eye on this as well.

China

Xi Jinping is trying to take China back to a soft version of the China that existed to the years after 1949. Australians have benefited from trading in iron ore which has often boosted the price but now speculation is not encouraged. I think it is going to be very difficult to restore our Chinese tourism and education industries because China is heading in a different direction. On the Australian front the most immediate aim of China was to reduce the iron ore price and they were successful.

Chinese equities have sold off hard this year, as Beijing intensified a regulatory clampdown. However, I have taken the bullish view and argue that the regulatory move by the government should not cause an existential crisis among investors. I would argue that it’s absolutely business as usual for investing in Chinese equities. The trick is not to see each thing that China says or does as an independent development. Chinese equities tend to rebound as much as 20% over the following six months. The downturn is a side-effect of the government’s efforts to transition China from a middle to high-income country within the coming five to 10 years. Crackdowns on industries from technology to education as regulators aim to improve competition should be viewed as a piece of the larger investment thesis.

For investors it is just about navigating these moments of volatility rather than going through an existential crisis every time we get these drawdowns. Perhaps it’s time to start thinking about a revisit. Valuations are now once again attractive, and I think the Chinese authorities will shortly begin to ease monetary policy settings in the wake of their economy slowing and weaker data prints. The Government must keep the economy growing and with the spread of Delta having an economic impact on growth, the tightening of policy settings six months ago could now go back into reverse.

Emerging markets

In emerging markets, the pace of recovery has varied widely. China, Korea, and Taiwan all responded swiftly to control the initial outbreak and have been essentially open for several quarters now. (It’s worth noting that China has recently instituted lockdowns again to control outbreaks, and we feel breakthrough outbreaks will continue to happen).

However, India endured a shocking second wave that overwhelmed the country’s healthcare systems as recently as May 2021, and Latin America also continues to suffer mightily in some areas. Though vaccination rates have started to trend up in emerging markets, the rollout in the first half of the year was slower than we had expected or hoped. One of the reasons for that is that relatively little vaccine manufacturing occurs in emerging markets. I feel that the uptick in inflation, a signal of strong economic growth, is generally a good thing for equities, especially in emerging markets. The earnings outlook is particularly strong for companies with the highest operating leverage, or those that stand to earn greater profits as sales increase. Both prices and input costs rise in an inflationary environment, but a high proportion of costs are fixed for a company with high operating leverage, putting them in a better position to maintain or increase profit levels as their revenues climb. The best scenario would be one in which inflation rises gradually to a level higher than what investors have become accustomed to over the last 13 years but fails to reach a level in developed markets that holds back economic growth.

Emerging Asia’s stocks and bonds have experienced a lost decade. Over the past 10 years, their returns have lagged those of global indices by a considerable margin. And that is even though these economies accounted for about 70 per cent of world GDP growth over the period.

Since the global financial crisis, both economic growth and price increases have been anaemic, the latter a likely result of prolonged quantitative easing and ultra-easy monetary policy. An environment of little-to-no inflation, or even falling prices for certain commodities and other goods, has been damaging for emerging markets. The return of inflation is a good sign for economic growth, and therefore, good for emerging markets equities—particularly those with the highest levels of operating leverage. Equities experts tend to think that core inflation will follow the path of developed markets inflation and push higher in the near term but remain contained in the medium term.

In the current environment, we believe being selective—among segments of the market and individual countries—will be key to capturing these returns. We see compelling value in three areas in particular: high yield hard currency sovereign debt, corporates, and increasingly, local currencies. We expect the countries included in the asset class to begin to recover in earnest in the second half of 2021 and continue into 2022, a more prolonged recovery than we would have suspected three months ago.

Gold

If the global economy fails to grow on the expected lines and supply chain disruptions continue to push the inflation upwards, gold may bounce back. Currently, certain central banks assessing the macroeconomic situation are buying gold and maintaining healthy gold reserves amidst times of the COVID-19 pandemic. While many commodity sectors have been running, some in my view are looking very attractive, currently. Particularly gold, which I continue to see as having a robust investment case, given my view that the inflation we see pushing through the system will prove anything but transitory. This is as the world sees a sustained economic rebound post Covid, and with the vaccine rollout ultimately trumping the delta outbreaks currently being experienced in many parts of the globe. Gold remains a time-honoured hedge against inflation and fiat paper debasement.

The US$ gold price has corrected and is yet to break free from the downtrend resistance in place since August last year. But I see this changing, as inflationary pressures becoming more permanent than many expect, and as the burgeoning deficits backing the US$ comes more into focus. For those high growth-oriented investors, it makes sense to approach gold strategically in 2021 by allocating around 10% to 15% of your entire investment portfolio to gold and with a long-term investment horizon. The long-term secular uptrend exhibited by gold is something that you cannot ignore and highlights the importance of owning gold in the portfolio as a diversifier.

Oil / WTIS

The economic impact of the Covid-19 Delta variant and rebounding output mean that expectations of global oil demand outstripping supply are fading. Investors have become concerned about falling commodities demand in China, where Beijing authorities last week cancelled all large-scale exhibitions and events for the remainder of August. That, and other measures aimed at slowing the spread of the Delta variant, has in recent days scared traders who were already worried about the fragile nature of China’s economic recovery.

The IEA cut its 2021 global oil demand growth forecast by 100,000 barrels a day, while upgrading its 2022 forecast by 200,000 barrels a day. Both the IEA and OPEC expect the world’s demand for oil to return to pre-pandemic highs in the second half of next year.

Most oil stocks have been poor investments even as the price of their underlying commodities have recovered from last year’s sharp shock, which saw the oil price crash to US$20 a barrel (and negative in one futures contract).Whether large or small, companies exposed to oil (and its close associate, natural gas) have struggled, either because oil is not an acceptable investment for environmentally conscious investors or its volatile price moves mean that it’s too risky and not sustainable.

However, there are currently several positive signs for energy shares, from rising stock prices, an upswing in second-quarter earnings and increased shareholder distributions. And if oil is staging a comeback, as some professionals believe is the case, then it becomes hard to ignore the value gap opening between the commodity price and most share prices.

Sector 12 Month Forecast Economic and Political Predictions
AUD 0.72-80c Australian export industries had become increasingly vulnerable to potential disruptions of market access to China due to rising concentration risk to that single market. This had become well recognized as a key risk by Australian policymakers and industry leaders in recent years although little concrete policy action was taken by companies to reduce their vulnerability to such trade concentration risk.
Gold $1,738 – $2,075

Hold

Gold prices and the greenback have an inverse relationship. As the dollar gets stronger against other currencies, gold prices will fall as it becomes more expensive in other currencies, driving down demand.
Commodities WTIS US$65 – US$80 Hold

Base metal complex will benefit from easy money policy. Iron ore sector is becoming interesting Energy is the only undervalued sector.

The outlook for iron ore (and other commodities) remains robust as the world reboots post Covid and will require lots of the steel-making ingredient. This includes China, and despite the country’s desire to clamp down on pollution in the steel sector.
Property This is a market for active stock-pickers. Record-low interest rates present a significant challenge for investors and their advisers seeking a healthy income yield, particularly for those depending on income from investments in retirement. With interest rates expected to remain “lower for longer”, Australian Real Estate Investment Trusts are well placed to generate reliable levels of income, with the potential for capital growth.
Australian Equities 6880 – 7650

Reduce

This is a market for active stock-pickers.

Share prices are higher than “fair value”. The market’s price/earnings multiple (as a measure of how stock prices compare to the profits companies are making) is currently sitting at roughly 19 times. That is historically high.
Bonds 1.5% – 2.5%

Short duration warranted.

An inflation-linked bond fund might be a good addition if looking for more inflation protection.

The COVID-19 vaccine’s global rollout has coincided with rising bond yields, as investors anticipate higher inflation on the back of the expected post-pandemic recovery. The Australian 10-year bond rate will top 2 per cent by the end of the year, as the resolve of central banks to support their economies will come under more intense pressure.
Cash Rates On Hold Cash & bank deposits are likely to provide very poor returns, given the ultra-low cash rate of just 0.10%.
Global Markets
America S&P 500 3900 – 4300

Underweight

Second quarter is likely the peak growth rate for both the economy and corporate earnings, with positive economic surprises waning. Inflation remains the key issue for the market, and inflation jitters are likely to keep the S&P 500 in a tight range until early July.
Europe European Index

Hold

After a slow start, the vaccine rollout is gaining pace and Europe should be on track for economic reopening by Q3. The post-lockdown recovery is likely to be extremely strong and GDP should bounce back by around 5% this year following last year’s near 7% decline. Europe’s exposure to financials and cyclically sensitive sectors such as industrials, materials and energy, and its small exposure to technology, give it the potential to outperform in the post-vaccine phase of the recovery when economic activity picks up and yield curves in Europe steepen.
Japan Hold The overall monetary policy framework is likely to be maintained for the time being. The central bank expects negative interest rates to be cut further only in emergencies, such as a sharp rise in the yen. Financial support measures for companies will expire in September 21, but financial conditions for accommodations, restaurants and other services remain tight. If the situation continues, the measures are likely to be extended.
Emerging markets Hold

Prefer Asia Emerging markets

Reports about COVID flare-ups and new lockdowns raise legitimate concerns about the near-term growth outlook in emerging markets. EM equities overall have been range bound over the past 13 years. Only recently has the MSCI Emerging Markets Index recovered to its peak levels in 2007. From a valuation perspective, emerging markets equities offer compelling valuations trading at 17.2 times the trailing price-to-earnings (P/E) ratio as compared with the MSCI All Country World Index (ACWI) at 24.5x.
China Accumulate Chinese stocks could struggle in the second quarter, as policymakers seek to rein in risky lending and the economic recovery from coronavirus accelerates elsewhere in the world. Beijing’s focus had shifted to normalising monetary policy after cutting interest rates during the health crisis, which could sap liquidity from markets in Shanghai and Shenzhen. Regulators’ recent crackdown on fintech and ecommerce companies such as Jack Ma’s Ant Group and Alibaba had also weighed on investor sentiment.

 

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