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LGT Private Banking Europe House View – May 2021

April 28, 2021

Financial markets have been experiencing a spring awakening for some time now, and positive economic indicators are giving rise to optimism. The focus continues to be on the monetary policy of the major central banks, first and foremost the Federal Reserve (Fed). Now, there is little doubt that the Fed will not raise interest rates in the coming months but will start to gradually reduce the additional liquidity injections (“tapering”). Against this backdrop, we focus on adequate risk compensation and prefer equities over bonds and commodities over liquidity.

LGT Private Banking Êurope House View

Spring is here and nature is slowly starting to wake up. On capital markets, we have already left the awakening phase behind and it is remarkable to see the speed and determination with which the equity markets, above all the S&P 500, have repeatedly rushed to new highs. There were hardly any setbacks worth mentioning in the first four months of this year. It is therefore hardly surprising that volatility in almost all asset classes has returned to levels seen before the outbreak of the corona pandemic. Indeed, there would have been plenty of reasons for a consolidation or correction, especially given the rise in interest rates at the long end in the US by more than 50 basis points. After one third of the year, it can be attested that the anticipated global economic recovery is taking center stage. In recent weeks, however, parts of the stock market have been very much driven by liquidity provided by central banks as well as massive equity funds flows.

A firework in US retail sales

Consumers are responsible for nearly 70% of US economic output. Therefore, it is not surprising that the government and the Federal Reserve are doing everything they can to keep consumers happy. Against the backdrop of three corona fiscal packages worth several trillion US dollars, Americans are in spending mood, thanks in part to the relaxation of pandemic measures in many places. This caused a veritable firework in the US retail sector, where sales have literally exploded in recent weeks and are also above the long-term trend.

The leading indicators (purchasing managers' indices) for both manufacturing and services paint a very positive picture for the coming months. From an economic perspective, we therefore expect hardly any major disappointments in the foreseeable future. This applies not only to the US, but also to Europe, where the vaccination campaigns should gain momentum and have positive consequences such as easing the corona measures, an improvement in consumer sentiment and increased economic momentum. With such a setup, the question inevitably arises whether central banks will need to tighten interest rates in the foreseeable future. In our view, however, this question is reduced primarily to the Fed – the ECB and the Bank of Japan have never been in a rate hike cycle since the financial crisis – because the Fed has a dual mandate: full employment and price stability. Inflation expectations have risen in recent months, but only temporarily, according to the Fed. By contrast, the labor market in the United States is still far from full employment, justifying the Fed remaining on the sidelines for the time being. We therefore do not expect US key interest rates to be raised in the next 18 to 24 months.

Tapering and taxes

At the moment, there is little doubt that while the Fed will not raise rates in the coming months, it will begin to gradually reduce the additional liquidity injections. This phenomenon, known in the financial world as “tapering,” is likely to create some headwinds for almost all asset classes. In our view, while this will not be a sustained game changer for equity markets, it will cause unease and turbulence, at least in the short-term, due to positioning and low volatility. Likewise, the US government's contemplated tax hikes are likely to add to jitters. President Joe Biden has no choice but to increase revenues, given the out-of-control national budget. When the US infrastructure package was announced, higher taxes for companies were already envisaged, and it is expected that Biden will also raise the capital gains tax. An increase in the income tax on wealthy individuals is also to be expected. All three factors mean an increased degree of uncertainty for investors.

Investment strategy – adequate risk

After more than a decade of ultra-expansive monetary policy, we must continue to take risks to be able to generate a positive nominal return at all. The situation for an investor thinking in Euro or Swiss francs remains more challenging than for a US dollar investor. The key issue for us is that we are compensated for the risks we take.

Across assets, at the top level of our investment strategy, we are sticking to our two convictions:

■ We prefer equities to bonds

■ We prefer commodities to liquidity

In equities, we remain positive on cyclical companies as they should continue to benefit from the expected easing of pandemic measures over the course of the year. On the bond side, we see little return potential in the coming weeks, except for the hybrid space. The investment grade sector has little potential, not only across assets but also within the fixed income quota, as credit spreads are very low not only by historical standards but also in absolute terms.

 

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Imprint
Publisher: LGT Bank (Switzerland) Ltd., Glärnischstrasse 36, CH-8027 Zurich
Author: Thomas Wille, Head Research & Strategy, Email: thomas.wille@lgt.com
Editor: Alessandro Fezzi, E-Mail: tina.haldner@lgt.com
Source: LGT Bank (Switzerland) Ltd.

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