The past four weeks have seen the rotation away from high growth as fears of higher yields continue to prove a significant headwind. This month, we look at the U.S. inflation scare, whether it is transitory, and what it all means for investors.
The rally is taking a pause once again, with tech and high growth stocks tumbling. The S&P/ASX 200 is slightly lower, having shed 0.4% over the past four weeks at the time of writing. The domestic tech sector is now down 18.9% for the year to date following last year’s blistering rally.
It’s a similar picture for global equities with the S&P 500 about 0.3% lower whilst the NASDAQ is off 4.4% despite earnings upgrades coming in at a blistering speed, with year-on-year earnings per share growth now expected to be close to 50% versus initial expectations of about 24% just prior to reporting season kicking off. Earnings beats are not being rewarded but strong reports across all sectors can be taken as positives, with valuations starting to look more in-line with the historical range, although still sitting on the upper end of that range.
Asian equities have been the detractors, with the MSCI AC Asia Pacific falling 3.8% over the past four weeks, driven by losses in Japan and Hong Kong.Bond yields were largely flat despite some big inflation figures from the U.S., with their 10-year yield around 1.6%. The Australian 10-year yield is also sitting around 1.75%.
Commodities continued to rally strongly, prompting China to attempt to jawbone prices lower. The comments sent commodity prices 5-10% lower but this is barely a dent in the recent rally. Brent Crude now sits close to USD $69 per barrel, copper rose to USD $4.70 and iron ore sits around USD $210. Gold also pushed past USD $1,850 per ounce.
Meanwhile, the Australian Dollar sits flat at 77.5 cents to the U.S. Dollar.
Another month, another round of strong domestic economic data. Business confidence has hit an all time high as manufacturing and services activity indicators continue to point to further improvement. The Federal Budget added further fiscal stimulus, continuing to support consumers and businesses.
Meanwhile, U.S. data over the past month has been bipolar. Despite the strength of many indicators, hard data like unemployment and retail sales missed the mark by wide margins. The market consensus was expecting close to 1 million jobs added but saw just 266,000 instead. On the other hand, inflation soared, with core CPI rising by 0.9% from March to April, three times the expected rate.
Over to Europe, the services sector is finally starting to recover again, alongside a gradual easing of restrictions as the vaccine rollout picks up pace.
In Asia, several countries are dealing with a resurgence of the virus, with some countries being forced into lockdowns once again.
Huge fiscal and monetary stimulus continues to support global economies and investment markets. These two pillars to the rally will continue to be closely monitored, with the Biden administration proposing further spending to be offset by higher taxes whilst investors are starting to get concerned about the potential for quantitative easing to be tapered earlier than expected.
Liftoff for U.S. inflation
Despite the rebound in yields and inflation expectations, actual inflation figures have been relatively muted for pretty much all major economies until the U.S. posted a big 0.8% monthly rise in the Consumer Price Index (CPI) between March to April. Core CPI, which excludes the volatile food and energy components, rose 0.9%. These figures were well ahead of the 0.2% and 0.3% respective consensus expectations, sparking a sell-off in high growth stocks that spilled over to the rest of the market, though dip buyers were quick to react, trimming losses fairly quickly.
Source: U.S. Bureau of Labor Statistics
A large rise in inflation shouldn’t have surprised the market as leading indicators such as input costs have shown a steep rise of late on the back of surging commodity prices, transport costs and supply constraints, though the magnitude of this rise was well above recent historical levels. To get a better understanding of what drove such a huge spike, and to understand whether it is likely to continue, the chart below from Goldman Sachs splits inflation components up into reopening beneficiaries, temporary supply disruptions and core services, showing plainly that a surge in transport and used cars have driven the bulk of the surge.
Source: Goldman Sachs
On the back of this, one would expect inflation to be transitory as per central bank commentary. The market largely agrees with this view, as yields only nudged higher. The arguments for inflation to stay structurally low continue to hold weight. Slowing population growth, ageing demographics and automation all remain firmly in place.
As a result, we remain sanguine on the outlook for equities and continue to expect global equities to trend higher in the medium term. The environment remains supportive as loose fiscal policy is a positive for earnings growth and easy monetary policy should keep bond yields contained, supporting valuations. However, we do concede that there is likely to be more volatility moving forward as expectations have also recovered strongly.
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This month’s perspective highlights that market sentiment on all asset classes is constantly changing. It is important for us to quickly recognise any threats, to preserve your investment capital or to identify early investment opportunities to maximise any return advantages. At Partners Wealth Group we don’t get complacent with the current state of play and constantly monitor investments and your portfolios.
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