July 2021 - First half behind us, now let’s talk about talking about…
June, like the first half of the year, was mostly positive for risky assets. Stock markets and high yield bonds were up, while investment grade bonds were down and trading at higher yields.
At the end of the month, the US jobs report again showed that growth is coming particularly from the recovery sectors, leisure, hotels, and restaurants, which accounted for 40% of the total jobs’ creation. The report also showed an increase in wages of 3.6% year on year, and further increases are anticipated. As mentioned in a previous letter, we continue to see part of the inflation more sticky than transitory, due to labor issues. The increase in wages is still lagging behind the inflation rate and employed and job seekers will no doubt continue to target higher salaries in order to maintain their purchasing power.
Turning once more to inflation, in June, the inflation rate jumped again and this time to 5%, the highest rate seen since 2008. The Core PCE (Personal Consumption Expenditure excluding Food and Energy) which measures the change in prices of the total goods purchased by Americans, and which is the main inflation linked data watched by the Fed, rose to 3.4% on a yearly basis, a level not seen since the early 90’s. However, during his testimony in Congress, Fed Chairman Powell said there is no chance that the inflation rate in the US will return to the levels experienced in the 70’s and 80’s, meaning a double-digit inflation rate. While mentioning the recent drop in lumber, he said that most of inflationary effects will resolve by themselves.
During their respective monthly meetings, the ECB and Fed left rates and policy unchanged, as expected. However, the divergence in policy between both started to widen, since the ECB said it will continue to conduct monthly asset purchases until at least March 2022, while the Fed already announced that it is planning two rate hikes within 2023 and is therefore expected to announce a tapering soon (process of reducing the purchase program gradually). During the last meeting Jerome Powell said, in reference to his earlier statement, that it was the “talking about talking about” meeting – starting to think about tightening the support provided so far. In addition, Powell increased the Fed’s inflation projection, slightly for 2022 and 2023 but more significantly for this year (to 3.4% from 2.4%), stipulating that it is “higher and more persistent” than anticipated. The GDP growth forecast was also revised upwards to 7% from 6.5%, for 2021.
Other important macroeconomic news included a G7 historical deal on global tax: a 15% minimum tax rate for international corporations, a deal that Treasury Secretary Janet Yellen wanted to pass in order to lower big companies’ relocations abroad for tax purposes. Another deal reached last month was the bipartisan infrastructure deal: $1 trillion to be deployed within 5 years on transportation, electric vehicles, electric transit etc.
The major world economy that still lags behind others this year is China: heavy regulation imposed by China on giant tech companies and a highly leveraged economy built in the last decade put shares of Chinese companies under pressure and investors seem to have stepped away from this investment sphere for now. The latest example is the fall of Chinese tech companies’ shares seen this week, following Chinese regulators’ crackdown on Didi for cybersecurity matters. Only a week after its IPO in New York, Didi’ stock was down more than 25% from its highest point and has pushed other Chinese Internet companies’ stocks down on investigation fears. It seems that China, that celebrated 100 years of Communism last month, wants to remind every source of capitalism that, after all, only the Party has control, even if it means shooting itself in the foot.
Although the general volatility came back to pre-COVID levels, for the financial sector, it was still a volatile month. At first, banks and financials were down, because of profit warnings on the trading part for the current quarter (kind of expected after the recent boom). Then, they corrected after the Fed released the bank stress test results which were successful for all the institutions; indeed, they were all well above the minimum capital levels required, showing strong financial resilience. Following the results of the test, all the major US banks announced an increase in dividends and share buyback programs.
Finally, a significant jump was also the one seen in Oil which reached a seven year high of $77/barrel at some point, following a strong disagreement which exploded between the United Arab Emirates and Saudi Arabia regarding output policy. This tension between the two largest Arabians economies is not new and not only oil related, but in the meantime, it led the OPEC+ meeting to be called off and the oil price to surge on uncertainties.
From our side, after a strong first half for equity markets, we adopt a “wait and see” attitude for this summer, which should confirm or reject the fast global recovery. Also, in September we may have more visibility on the impact of the Delta variant, the Fed’s tapering, companies’ first half earnings and final forecasts for year end. Overall, we stay positive despite the more “hawkish” tone of the Fed, which is, after all, a good sign that we are moving in the right direction and therefore the economy will need less support. Having said that, we stay aware than we are still in an incredibly supportive environment, and even with two rate hikes to come until end of 2023, we will likely be left with interest rates below 1%, and therefore, the only alternative that seems to remain interesting is the equity market.
As always, risk-management combined with rigorous sector and geographical diversification will remain key factors for investment performance.
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