Macro update: July 2021
Welcome to our monthly macro update. Here we provide an overview of our current market views, and our recommendations for strategic portfolio positioning.
Has growth peaked?
Economic growth is coming through at pace, reflected in the fifth consecutive quarter of positive equity performance1, but as countries emerge from the pandemic, at what point will growth peak? PMIs (business surveys) are powerful indicators of expectations around future economic growth and equity performance, and while they have reached record levels of late, now they are fading. As pent up consumer demand accrued during lockdown diminishes and fiscal support withdrawn, we expect PMIs to slow in tandem, albeit we expect them to remain healthy for some time yet. When PMIs peak this is a predictor of a slowing economy in 9-12 months, suggesting a positive outlook for at least the rest of 2021 (as shown in the chart below). However, with this economic cycle unfolding faster than expected, our view is that there are risks growth could peak earlier than expected. Were this to materialise it would pose a headwind to cyclical sectors (which benefit from strong economic environments), . This would signal the beginning of the rotation towards defensive growth-style companies. We advocate a more balanced equity positioning without high conviction style and sector biases, while still maintaining an overweight equity allocation.
PMIs and equity performance are closely linked
Source: Bloomberg 2/7/2021
1 - reflective of a broad global equity index MSCI ACWI as of quarter end
What happens when monetary stimulus is withdrawn?
We have long said our preference for equities is in part driven by the ongoing stimulus support from policymakers. So how would our views change if monetary stimulus were to be withdrawn? Markets have been nervous at the prospect of a premature withdrawal, with a gradual and well-signposted tapering of monetary policy the most desirable outcome. However, even in this scenario it would signal the beginning of the end of the extremely supportive environment for risk assets and would likely have meaningful implications across multiple asset classes. We would expect upwards pressure on real government bond yields (the yield adjusted for inflation), increasing the cost of borrowing, and restricting governments’ ability to continue to run the meaningful fiscal deficits they have over the past year. However, as demand and business confidence remain high, we expect government stimulus to be replaced by private sector spending, supporting employment levels and economic growth.
We believe even the strong earnings expected this year probably cannot offset the powerful headwind effect of higher real bond yields on equities. This is shown in the chart below where higher real bond yields weigh on prospective 18-month equity returns). While we still expect equities to rise in the short term, as the removal of stimulus grows ever-closer, we expect to reduce equity risk slowly in favour of lower volatility return-seeking assets.
High real yields can weigh on equities
Source: Bloomberg 2/7/2021
Snapshot of views
Economic growth is coming through at pace, but at what point will growth peak? As pent up consumer demand diminishes and government support withdrawn, we expect economic growth to slow over the coming year.. If growth peaks earlier than expected it will likely act as a headwind for cyclical sectors and be a catalyst for a rotation back towards defensive growth-style companies. Markets have been nervous at the prospect of a premature withdrawal of stimulus, but even a slow withdrawal of support will likely put upward pressure on real government bond yields. This could weigh on equities, and we advocate trimming equity risk in favour of lower volatility assets as we move through the economic cycle.
Time to rotate to alternatives?
As we progress at pace through the economic cycle in a post-pandemic world, what opportunities will arise? An environment with rising volatility and more sector rotation could well be the perfect environment for alternative assets. With distinct return drivers from traditional assets, a strong portfolio of alternative assets can provide the advantage of more reliable cashflows, lower volatility (as shown in the below chart) and downside protection. While our base case is still an accommodative environment for equities, with much of the easy gains likely behind us, we view alternatives that produce consistent returns regardless of the economic environment as more attractive as fading growth acts as a headwind on traditional assets. Within alternatives, allocating to liquid hedge funds that have low market exposure or benefit from elevated volatility can help provide sources of stable income and provide meaningful diversification benefits. We advocate increasing exposure to liquid alternatives as equity allocations are trimmed retaining the ability to rotate assets at short notice.
Hedge funds are less volatile than equities - a benefit later in the economic cycle
Source: Bloomberg 2/7/2021
This article has been issued and approved by River and Mercantile Solutions, a division of River and Mercantile Investments Limited which is authorised and regulated in the United Kingdom by the Financial Conduct Authority (Firm Reference No. 195028; registered in England and Wales No. 3359127) and is a subsidiary of River and Mercantile Group Plc (registered in England and Wales No. 04035248), with its registered office at 30 Coleman Street, London EC2R 5AL. Please note that all material produced by River and Mercantile Investments Limited is directed at, and intended for, the consideration of professional clients only within the meaning of the Financial Services and Markets Act 2000 (“FSMA”). Retail clients must not place any reliance upon the contents .The information expressed has been provided in good faith and has been prepared using sources considered to be reasonable and appropriate. While this information from third parties is believed to be reliable, no representations, guarantees or warranties are made as to the accuracy of information presented, and no responsibility or liability can be accepted for any error, omission or inaccuracy in respect of this. This article may also include our views and expectations, which cannot be taken as fact. The value of investments and any income generated may go down as well as up and is not guaranteed. An investor may not get back the amount originally invested. Past performance is not a reliable guide to future results. Changes in exchange rates may have an adverse effect on the value, price or income of investments.
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