Global economic growth remains above potential output 18 months after the outbreak of the corona pandemic and the possible start of a fourth wave. We expect growth to remain above potential in the coming months, but momentum is likely to weaken compared with previous quarters. In China, this can already be seen in the economic data and the US is likely to follow this path in late summer and fall. In Europe, and especially in the eurozone, momentum remains relatively solid, as the large-scale vaccination strategy in continental Europe – compared to the US – has started later. Likewise, the global surprise indicators, which show how strongly realized economic data exceed analysts' expectations, are no longer as high as in the spring. While this was to be expected as the base effect slowly disappears, the development is likely to lead to increased nervousness among investors, especially if expectations are too high and are not met. In absolute terms, the economic environment remains positive for capital markets in the medium-term.
When the rate of change in growth weakens, this often has a negative impact on financing conditions. However, they remain very supportive at the moment. Thus, in the US, we are observing the most attractive financing conditions in 30 years. This is hardly surprising, as we have never experienced such stimulus in the financial system. The Federal Reserve continues to be very expansionary, pumping around USD 120 billion into the markets every month (USD 80 billion in government bonds and USD 40 billion in mortgage-backed securities). Since the outbreak of the pandemic, its balance sheet has grown from USD 4.12 trillion to USD 8.25 trillion by now. The reduction of this money glut, i.e. the scaling back of quantitative easing, has now been postponed until spring 2022 – but postponed is not cancelled. The Fed is in a very comfortable position at the moment, as medium- to long-term inflation expectations have fallen slightly in recent weeks and at 2.15% are far away from 2.75 to 3.0%, which would put the central bank under pressure.
During the euro crises, the focus was on austerity to get government budgets back in order. The word “austerity” was on everyone's lips, and the two largest economies Germany and France wanted to manage the crises with austerity measures. Today, austerity is a thing of the past, as structural deficits in the eurozone have risen sharply in 2020 and 2021. The enormous corona aid packages, as well as the billions of euros in infrastructure investments, are a clear shift compared to previous crises. These packages and a zero interest rate policy continue to create a good environment for companies in the eurozone.
In our view, the glass remains half full in the medium-term, but investors should increasingly keep an eye on risks. In our view, a possible moderate economic slowdown in China is a risk that could make the market nervous in the short-term and cause the low volatility to rise. Similarly, a change in the Federal Reserve's rhetoric at the upcoming interest rate meeting or at the important symposium in Jackson Hole at the end of August could cause volatility. In addition, a fourth wave of Covid-19 is looming, with investor focus at the moment less on the number of new infections in the G7 nations, but on hospitalizations and related bottlenecks in hospitals. At an asset allocation level, we continue to favor equities over bonds, with a focus on selection in both asset classes. We also continue to see potential in commodities versus the liquidity ratio. In alternative investments, gold is our favorite in the medium-term and should be accumulated in weak phases.
Equity market valuations remain in the top quartile, but corporate earnings and earnings revisions continue to be supportive. However, the focus is clearly on individual company-specific quarterly results and the outlook for the second half of the year as well as 2022. We continue to favor companies that have pricing power over those that cannot pass on price increases to their customers. We also see potential in defensive stocks, which have tended to be neglected in the first half of the year but still show solid earnings growth. In addition, we are favoring European utilities, where we see catch-up potential due to weak performance. Earnings growth remains intact and the sector is attractively valued. At country level, Europe remains our preferred region. Meanwhile, China adopted new regulations aimed in particular at forcing companies in the education sector to convert to non-profit organizations. This clearly increases uncertainties and weighs on market sentiment. Chinese equities have now wiped out all gains year-to-date, and due to their significant weight in the broad MSCI Emerging Market index, they drag down the whole emerging market space. Due to the significant policy and regulatory overhang in China, we prefer to lower our view on emerging markets back to a “neutral” stance and to step to the sidelines for the time being.
We continue to recommend a short duration, as yield curves are very flat and we expect slightly higher interest rates in the US by the end of the year, despite the expansionary monetary policy. Yields on ten-year US government bonds, for example, are likely to rise to as much as 1.75% if growth forecasts materialize. In the eurozone, the European Central Bank (ECB) is likely to stifle any significant increase at the long end of interest rates, and the same applies to a widening of spreads in the individual eurozone states. We remain positive on subordinated bonds as well as emerging market bonds in local currencies, as investors receive relatively attractive risk premiums in both sub-segments. Selection is key here as well, in our view.
Publisher: LGT Bank (Switzerland) Ltd., Glärnischstrasse 36, CH-8027 Zurich
Author: Thomas Wille, Head Research & Strategy, Email: firstname.lastname@example.org
Editor: Alessandro Fezzi, E-Mail: email@example.com
Source: LGT Bank (Switzerland) Ltd.
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