Vaccine progress, strong earnings, ongoing spending programmes and extraordinarily accommodative monetary policy all continue to hail strong growth prospects as the world continues its emergence from the Covid-19 crisis. This has come with inflationary fears, and while base effects are indeed likely to fade, the prospect of higher inflation should be opportune for those more defensive names that are more sensitive to price pressure (i.e. healthcare and staples). We maintain our view that equities can continue to grind higher driven by reopening trades where upside potential remains. But leading indicators have been peaking and risk appetite fading in what proved a fairly volatile May, and we think we could see the market evolve in period of sideways consolidation through the lacklustre yet more unpredictable summer months. So while we continue to favour the recovery themes, in our view it is an opportune moment to consider once again some of those more unloved defensive names with which to navigate markets taking a slightly lower risk approach.
Outlook as at 03.06.2021
What have our equity quant indicators been telling us?
Since our May update, Europe's score in our equity regional matrix (the top-down indicator that gives us a regional view*) having flirted with very bullish territory mid-May is now back in bullish territory (24%). Sentiment continues to improve while the valuation grade remains extended (at -78%). Vaccination programmes in Europe continue to gather pace and many countries are now pushing ahead with reopening ahead of the crucial summer season. Macro data continue to reflect signs of economic improvement; the recovery now expected to accelerate with Next Gen EU funds launching in next couple of months. Accordingly we continue to expect reopening trades to outperform (in particular those that can ride the urban renovation, green and digitalisation themes) – while those now looking among the more traditionally defensive sectors might consider Swiss names and Food & Bev (both of which are now looking technically more alluring).
The US’ regional score in our matrix has remained steady since our last edition, falling only slightly over the past month to 21% from 24%). The trend score has strengthened to 92% while the valuation score remains ‘extended’ at -96%. After a strong April a more volatile May did allow the S&P500 to close the month in positive territory but it felt more hard won and we expect to see some more sideways consolidation over the summer months. Base effects and reopening has brought about spikes in growth and inflation measures as widely expected, however the Fed remains adamant that these will prove transitory and continues to insist that it will not consider a shift in policy until it its inflation target has been met and it sees hard evidence of normalisation in the labour market (the Jackson Hole symposium in August now broadly expected to be the next marker in Fed communication). Moreover we expect the strong earnings momentum of Q1 to extend into Q2, as fiscal policy, vaccines and (manageable) reflationary pressures continue to support broad-based equity market performance – reopening themes including consumer stocks, reopening names and infrastructure themes (and again we consider there to be much opportunity in areas associated with the green themes) – but again also consider turning a touch defensive.
Japan’s regional score in our matrix, while still ‘very bullish’ has cooled to 37% from 52% a month ago; the trend, sentiment and economics parameters all softening a little recently. We continue to prefer exporters as beneficiaries of the Asian recovery (while the imminent Olympics – should they go ahead – could boost lagging domestic consumption) and we also continue to favour quality cyclicals in the region.
Emerging market equities have fallen to ‘bullish’ territory over the past month – now at 13% - the trend score having dropped significantly from last month’s 99% but this past week recovering to 49%. The outlook for EM equities remains positive given the lower US dollar environment and strong commodity prices as well as returning international trade and solid manufacturing activity. However dislocations and divergences remain and we maintain that over the short-term taking a more tactical approach to the same could be preferable.
Outlook as at 03.06.2021
On the macro front the 10-year US Treasury yield (having spiked to 1.7%) has fallen back to the 1.54 region where we have been seeing some lateral consideration, and while we consider rates capped over the medium term, we nevertheless anticipate a pickup from current levels (as the reflationary environment continues to strengthen) our core scenario being a rise on towards the resistance level at around 1.86. Inflation break-evens should stabilise as supply issues fade and while we believe the Fed will hold off on raising base rates, real rates will start rising again as Fed tapering talk gathers momentum (as could the US dollar could get a temporary reprieve upside if tapering talk gathers pace or if increased market volatility leads to safe-haven inflows into US assets). Our year-end forecast for the 10-year US Treasury remains 2.1%.
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The Trading Strategy Team
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