Monthly macro update – July 2021
Snapshot of views
As pandemic-driven pent up consumer demand diminishes and government support is reduced, we expect economic growth to slow over the coming year, albeit from currently high rates in much of the world. The uneven rollout of vaccines, the impact of virus variants such as Delta, ongoing supply chain disruption and different levels of government support mean that global economic recovery is not uniform. This is seen clearly in widely varying measures of consumer price inflation (e.g. very high in the US, very low in parts of East Asia), though globally stock markets continue to generally perform well, pricing in full recovery from the pandemic. Given that the pandemic looks to be closer to the end than the beginning in much of the world, and with stock prices for companies most leveraged to re-opening having largely recovered from their 2020 lows, we are trimming out overweight positions to cyclical equities (e.g. “Value” stocks and Europe/Japan) in favor of non-cyclical equities (e.g. “Growth” stocks and the US). We maintain overweight positions to equities vs. fixed income.
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. Moving forward, we would expect PMIs to slow in tandem with a reduction in global stimulus. Historically, a peak in PMIs has signaled a slowing economy in 9-12 months, and which in turn is correlated with lower equity returns. However, with this economic cycle unfolding faster than previous ones, there are risks growth could peak earlier than expected. Were this to materialize it would pose a headwind to cyclical sectors (which benefit from strong economic environments). This would signal the beginning of the rotation towards companies that are less economically sensitive. We advocate a more balanced equity positioning without high conviction style and sector biases, while still maintaining an overweight equity allocation.
Source: Bloomberg 07/02/21
1reflective 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What happens when monetary stimulus is withdrawn?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 support from governments. So how would our views change if monetary stimulus (e.g. low rates & central bank asset purchases) 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 equity returns (18 months forward). While we still expect equities to rise in the short term, as the removal of stimulus grows ever closer, we expect to reduce our currently overweight equity positions.
Source: Bloomberg 07/02/21
Investment advisory services are provided by River and Mercantile LLC, an investment advisor registered with the US Securities and Exchange Commission. It is a subsidiary of River and Mercantile Group PLC, a U.K. corporation.
The information and opinions contained in this document do not constitute investment advice and is provided for background purposes only. References to specific securities are provided solely as illustrative examples of the River and Mercantile LLC analytical methods, and are not a recommendation to buy or sell such securities. This information is subject to updating and verification. Portions of this presentation are based on data provided by third parties whom River and Mercantile LLC deems to be reliable; however, River and Mercantile LLC cannot guarantee the accuracy and completeness of the information.
PAST PERFORMANCE IS NOT AN INDICATION OF FUTURE RESULTS.
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