August 2021 - An Olympic But Not All Epic Month
Markets in July were mixed across the board: positive for the US markets where the main indices continue to trade near record highs but pretty much flat for European ones, and strongly negative for those in Asia Pacific which lost between 5 and 10% during the month.
On the fixed income side, investment grade bonds rose slightly with the 10-year treasury yield down 24 bps during the month, returning to February levels, at 1.16%. High yield bonds were trading slightly lower.
Rates and policies were left unchanged by both the European Central Bank (ECB) and the Fed, however while the tone remains dovish in the Eurozone, the Fed is already preparing the ground for a future tapering, indicating that it could start with lowering Mortgage-Backed Securities (MBS) purchases before Treasuries.
Another divergence between the Fed and the ECB is how they see Delta Variant impact. If the Fed doesn’t yet consider it as a potential game changer, ECB’s chairwoman Lagarde admitted it constitutes a growing source of uncertainty for the economic recovery.
Regarding inflation, divergence continues between the different Fed members, some of them see it stickier than Powell’s acolytes, who see its effects mainly coming from the reopening of the economy, and therefore transitory. The latest data showed indeed that a surge of 45% year-on-year in used cars prices drove the inflation rate up to 5.4%. However, even Jerome Powell has now admitted that the inflation rate was higher, and that inflation was lasting longer than originally anticipated.
Economic data is still mostly encouraging for the US as well as for the Eurozone. The latest numbers showed that the US economy grew by 6.5% during the second quarter (quarter-over-quarter) while the Eurozone’s GDP second quarter growth came in at 2%, after two quarters of contraction. Regarding the unemployment rate, while it disappointed in the US with a rate at of 5.9%, it was lower than expected in the Eurozone, but still close to 8%. This Friday, the July jobs report will be released in the US, an event highly watched by the Fed and that could be crucial for its future decisions.
After weeks of negotiations, the bipartisan infrastructure package of $1 trillion was drafted and amendments are now being voted for both the plan and its budget. This is a key legislation for Joe Biden’s agenda, and a huge process for the whole US for years to come, with major projects planned for roads, bridges, ports etc.
Once again last month, the bad news came from China as it continues to crack down on Chinese companies, not only from the tech sector but also from the education and healthcare industries. This new crackdown on the private tutoring sector is meant to reduce educational gap between poor and affluent families and lessen the disincentive for larger families, as private education is usually expensive and so it could discourage Chinese couples to have more than one child. The issue is that becoming non-profit companies overnight makes their stocks practically worthless as well as causes huge job losses right across the industry. Therefore, since restrictions and regulations could possibly hit every sector now, from big companies to small ones, not only foreign investors prefer to stay away, but also Chinese business confidence took a hit, because these kinds of measures tend to discourage young entrepreneurs from building new businesses.
Alongside these moves, the People's Bank of China, (PBoC) decided to lower the Reserve Requirement Ratio by 0.5 % to 8.9%, meaning that banks would be able to hold less cash and therefore to grant more credit. Although the PBoC said it was “nothing special”, this cut is seen as an easing tool and is not usually used if growth is doing well. Investors will need concrete moves or announcements to build back a positive sentiment on China, and we assume the Chinese government is fully aware of it. Therefore, the ball is firmly in their court.
To a lesser extent, President Biden signed an executive order last month aiming to expand competition and fight monopolistic practices across all industries. According to him, too much power was given to some companies, and it has resulted in declining standard of living for Americans.
Finally, July marked the second quarter earnings season’ “kick off”. More than half of the S&P 500 companies have reported so far and once again a large majority released better than expected earnings and revenue. But the most interesting fact, is the phenomenal 85% growth in earnings for Q2, making it the highest year-over-year growth rate since 2009. From this level, even if earnings will continue to increase for the future quarters, it will surely be at a slower pace.
There is no fundamental reason to have a negative sentiment on the markets right now, but we stay aware that a slower growth is more than likely. However, with a 10-year real interest rate at historical low (negative 1.17%), equities are still the most appealing asset class, and we cannot afford being underinvested. Also, if inflation is going to pay for governments’ spending, as it seems to be the case for the time being, companies’ stocks will be the first to take advantage of it.
As always, risk-management combined with rigorous sector and geographical diversification will remain key factors for investment performance.
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