While it wasn’t all smooth sailing for investments in April, markets closed largely higher as bond yields stabilised and reflation trade continued its course, explains George Lin.
|Written by George Lin
Senior Investment Manager | Colonial First State
In April, a range of market developments as well as concerns about the safety of Coronavirus vaccines caused investors some apprehension as to the pace of immunisation and the strength of the global economic recovery. However, economic data released over April was generally strong, especially in the US. And unlike our experience in the March quarter, where bond yields reacted negatively to stronger economic data, we saw yields stabilise in April – strengthening share markets. By month’s end, the ASX 200 was up 3.5% while the Australian Dollar (AUD) traded at 77.2 US cents.
Temporary clots in vaccine programs
Headlines were largely dominated by the potential blood-clotting issues associated with the Oxford AstraZeneca and Johnson & Johnson vaccines. While the statistical probability of the two leading to serious medical problems is reportedly small, health authorities were still cautious. A number of countries, including Australia, recommended that younger people seek an alternative to AstraZeneca. The US also paused the use of Johnson & Johnson for two weeks, but resumed its use at the end of the month after a study concluded that the benefit of continued use outweighed its potential costs.
The negative impacts of these setbacks are likely short term, with the most likely consequence a slight delay in achieving herd immunity. Over the month, developed economies continued to make solid progress with their vaccination programs. Financial markets believe that by the end of September, the US, the UK and most of Europe will have achieved full herd immunity. In comparison, the availability of vaccines continued to be a major issue in developing economies, leading to a mixed outlook for emerging markets. For example, India is currently in the midst of a crippling second wave of coronavirus, with new daily cases running at around 320,000.
Vaccination by country as at 25 April 2021 (Source: Worldometre)
|Country||Doses (per 100 of population)||Daily doses administered (per 100 of population)||Day until herd immunity|
The availability of vaccines has continued to be a major issue in developing economies, leading to a mixed outlook for emerging markets. India is currently in the midst of a crippling second wave of coronavirus, with new daily cases running at around 320,000. And after a slow start, China has begun catching up – so far administering at least one dose to 15.3% of its population. This translates into 224.9 million doses, which is the second highest in the world after the US.
Global economic data released in April was generally strong. The recovery in the global manufacturing sector accelerated further, with strong rises in the US and European Manufacturing Purchasing Managers’ Index (PMI). The Manufacturing PMI for China has been steady over the last few months, reflecting the country’s early recovery and, possibly, the less expansionary state of Chinese monetary policy. While it still lags, the Services PMI in both the US and China has continued to rise. European Services was hampered by earlier lockdowns, but is starting to show signs of a recovery as some measures are eased in response to lower case numbers across the continent.
US economic data continued to beat expectations, signalling a faster-than-expected economic recovery. In particular, US non-farm employment rose by a much stronger than expected 916,000 positions in March. This is by far the strongest monthly job growth since August last year when the US economy re-opened after the initial lockdown. Leading indicators, such as the number of job openings, are pointing to further gains in employment. The easing of social restrictions and the latest transfer payment under the Biden fiscal plan led to a strong 9.4% surge in March US retail sales. While the same level of growth is unlikely to be repeated in April, improvements in the labour market and in consumer confidence point to continuing strength in US consumer spending.
Australia continues to make a strong recovery from the pandemic-induced recession. Employment rose by more than 70,000 in March, the sixth consecutive monthly rise in employment. Australia has now recovered all lost jobs during the pandemic. In fact, the level of employment was higher than the pre-pandemic peak in February 2020. Retail trade rose 1.4% in March – the strongest monthly rise since November 2020, reflecting steadily improving consumer confidence driven by a combination of positive pandemic news and rising house prices. There is also good news on inflation. The Australian Consumer Price Index (CPI) rose 0.6% on a quarterly basis and 1.1% on a year-on-year basis over the March quarter. Further, the Reserve Bank of Australia’s preferred measure of underlying inflation rose 1.1% on a year-on-year basis. While the low price increase is reportedly distorted by some one-off changes, it seems inflation remains low despite the strong recovery in economic activity – meaning, the central bank will maintain a low interest rate regime for longer.
A significant market development in April was the stabilisation of global bond yields. After surging last quarter, US bond yields retreated. The Australian 10-year bond yield also fell to 1.68% by the end of April. There are a number of factors driving the stabilisation in bond yields. However, one prominent driver may be that after the sharp rise in yields driven by surging inflation expectations, investors believe current yields are reasonable given central banks’ policy guidance and economic outlook.
Yield stabilisation provided a supportive environment for shares, which had a positive month. The ASX 200 rose 3.5%, the Euro STOXX 600 rose 1.85%, the Hang Seng rose 1.22%, and the S&P 500 rose 5.24%. Lower bond yields boosted growth stocks, with the NASDAQ returning a strong 5.4%. As in the March quarter, stocks in the resources sector continued to benefit from stronger commodity prices that are being driven by the global manufacturing recovery. In Australia, for example, the ASX 300 Resources Index surged by 6% in April and outperformed the ASX 300 Industrial Index by 2.9%.
Some track left on the reflation theme
At this time, it seems that the global reflation theme has not yet run its course. For this reason, we anticipate that growth assets (in particular, shares) may be preferred by markets. This is based on strong US economic data given the low interest rate environment, supportive fiscal policy and positive vaccination progress. In particular, the recovering US Services sector, which has been a relative laggard, will likely accelerate as social-distancing restrictions ease further. This pattern of recovery, which eventuated first in China and the US, will likely repeat across Europe over the coming months as their vaccination programs and economic re-openings play catch-up.
We also anticipate that the economic recovery will boost corporate earnings and be supportive of the currently lofty valuation of share prices. Looking ahead, it seems US stocks are on a solid path of revenue and earnings recovery. Strong earnings are evident in the current US quarterly reporting season. Of the 60% of companies in the S&P 500 reporting results for the March quarter, 86% have reported a positive earnings-per-share surprise, while 78% reported a revenue surprise.
But with that said, share markets have largely priced in most of the good news and should therefore generate a respectable – but not spectacular – level of return between now and the end of 2021. Since March 2020, the ASX 200 has generated a 31% return while the MSCI World Net Index (AUD hedged) has generated 40%. We are confident that this level will not be repeated over the next 12 months.
Still some risks ahead
It seems the main risk for world financial markets is another sharp rise in global bond yields, triggered by significantly higher inflation.
Investors expect a rise in US CPI inflation due to the base effect , tighter labour markets and upstream price pressures. The consensus it that this spike is transitory and will revert towards the midpoint of the US Federal Reserve’s (the Fed) inflation target of 2–3% by the end of 2021. If US inflation turns out to be higher and more persistent, bond investors will likely be aggressive in response and drive US bond yields higher. The speed and magnitude of a rise in bond yields could be a key influence on share markets. As in the March quarter, growth stocks (which are dependent on a distant rise in future earnings to justify their high valuations) may be particularly vulnerable to higher bond yields.
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