Monthly macro update: May 2021
Snapshot of views
Company earnings growth is materializing better than expected, particularly within cyclical sectors. Almost one in four companies have surprised on the upside, helping drive the S&P 500 to its best month since November. The ‘Big 5’ (Apple, Microsoft, Amazon, Facebook and Google) represent 22.8% of the S&P 500 and also 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 increases have emerged from the Biden administration, but equities have remained resilient. We see the proposed infrastructure spending as supportive for growth and employment. Supply chains and input cost remain a headwind, but should be sorted over time as capacity comes back online.
Can earnings drive equities higher?
Previously we mentioned a recovery in company earnings would drive equities higher this year, rather than ‘multiple expansion’ (prices rising faster than earnings). This is materializing, particularly within cyclical sectors. US earnings have risen 46%1 in the first quarter from the previous year, exceeding the expected forecast of 24%. This is encouraging, as it supports our overweight equities view.
Both cyclical and “growth” stocks have posted strong earnings, but growth companies have underperformed of lately. How much do equity indices rely on these companies performing well? Earlier this year we saw the impact that large growth companies (like the Apple and Google) 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 prices weakened, negatively impacting entire indices. 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 economies. While we expect government bond yields to continue to have short term upwards pressure, for now they have stabilized. As a result, we still believe the macro environment remains supportive for equities and in particular, to those tied to the economic cycle.
Source: Bloomberg 05/05/21, 1Reuters
Could Biden's agenda be a headwind?
Over 100 days into the Biden administration, we now have some clarity on key policy areas, with planned increases to corporate and capital gains taxes. While tax increases could act as a headwind for future equity prices, markets have taken the proposals in stride, at least in part probably because what is proposed, and what the final numbers will be, may be very different. Also, these tax increases would be accompanied by increased spending, which is positive for many stocks.
How will climate commitments impact markets?
Perhaps the most notable of Biden’s announcements 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 tax credits for electricity production from renewable resources. As a result, there will be clear winners and losers that 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 as quickly.
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.
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