Macro update: May 2021
Welcome to our monthly macro update. Here we provide an overview of our current market views, and our recommendations for strategic portfolio positioning.
Can earnings drive equities higher?
Previously we mentioned a recovery in company earnings will drive equities higher this year, rather than ‘multiple expansion’ (prices rising faster than earnings). This is materialising, particularly within cyclical sectors. US earnings have risen 46%1 in the first quarter from the previous year, exceeding the expected forecast of 24%. Almost one in four companies have surprised on the upside, helping drive the S&P 500, America’s leading equity index, to its best month since November 2020. This is encouraging, as it supports our high conviction equities view. The ‘Big 5’ (Apple, Microsoft, Amazon, Facebook, and Google) represent 22.8% of the S&P 500 and recently posted strong earnings ahead of expectations. But despite these strong earnings, we have still seen growth companies underperform of late.
So how much do equity indices rely on these companies performing well? Earlier this year we saw the impact these companies can have on headline indices. The high growth expectations priced into these company valuations make them more susceptible to a rise in government bond yields, and as government bond yields rose, these stocks weakened and dragged entire indices down. However earnings growth elsewhere, particularly within cyclical sectors, has been sufficient to drive equities higher as they continue to benefit from ongoing monetary and fiscal stimulus and the reopening of societies. While we expect government bond yields to continue to have short term upwards pressure, for now they have stabilised. As a result, we still believe the macro environment remains supportive for equities and in particular those tied to the economic cycle.
Percentage of sector in S&P500 reporting an earnings surprise
Source: Bloomberg, 5 May 2021. 1 - Reuters
Snapshot of views
Company earnings growth is materialising, particularly within cyclical sectors. Almost one in four companies have surprised on the upside, helping drive the S&P 500, America’s leading equity index, to its best month since November. The ‘Big 5’ (Apple, Microsoft, Amazon, Facebook and Google) represent 22.8% of the S&P 500 and posted strong earnings. We continue to expect earnings growth throughout the year to drive equities higher, supported by record US GDP expectations and the increase in household savings from US government stimulus.
Key policies such as tax rises have emerged from the Biden administration, but equities have remained resilient. Most notably however are the infrastructure and carbon commitments which we expect will propel growth and employment over the coming years through the green transition.
Climate change will take centre stage and is certain to play a part in influencing investment returns. This is why we consider ESG momentum, enabling us to allocate toward companies that may not be the best ESG companies now, but are improving, rewarding shareholders in return.
Could Biden's agenda be a headwind?
Over 100 days into the Biden administration, we now have some clarity on key policy areas. Planned increases to capital gains and corporation taxes have been centre-stage, and importantly the impact these could have on financial markets. While both could act as a headwind for future equity prices, we are aware of the complexity and time required to pass such legislation undiluted, and hence don’t see this as an immediate threat.
Equities were resilient considering the news, in part because of the ambitious spending plans those taxes would be funding. Further fiscal spending, most likely through infrastructure,
will be a top priority. We view this as supportive of US growth, employment and consequently asset prices, and we are seeing other countries such as the UK following suit.
Infrastructure assets under management are rising exponentially
Source: Preqin, 5 May 2021
How will climate commitments impact markets?
Perhaps the most notable of Biden’s announcement was the commitment to cut carbon emission to half of 2005 levels by 2030. This is significant. If passed into law, it paves the way for continued fiscal stimulus and economic growth required to transition the US economy. While announcements have been light on detail, initial levers include the retirement of coal plants and subsidies for electric vehicles. As a result, there will be clear winners and losers which will likely require a dynamic approach to navigate. Those companies able to innovate and pivot towards greener methods will likely outperform those unable to transition at pace. This is exactly why we consider ESG momentum when looking for the best companies to invest in. This enables us to allocate toward those who may not necessarily be the market leaders in ESG today, but are improving at pace while avoiding those companies who in 5 years may be well behind the curve. But ESG as an investment style has struggled over the previous 6 months with some of the lower-scoring areas of the markets such as Energy rallying at pace. So could prioritising ESG weigh on future returns? We think this is unlikely. We have a high level of conviction that over the coming decade ESG strategies will add value, with well-governed companies best placed to manage the ‘transition risk’ that climate change presents.
This will likely coincide with the rotation back to innovation and higher quality companies when equities reconnect with market fundamentals over the coming 18 months.
ESG momentum can add meaningful value
Source: River and Mercantile, 5 May 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.
“The decade of delivery” – the Fiduciary Manager’s role in combatting climate change
“The decade of delivery” – ...
A year into what the UN has called the ‘decade of delivery’ for its 17…5 min read
Engaging with fund managers to deliver better ESG outcomes
Engaging with fund managers to ...
Ajeet Manjrekar explains how ﬁduciary managers can support trustees to meet their regulatory obligations by…3 min read