With the exception of Japan, the US, Europe, and China continue to recover from the impacts of Covid19.
That said, with the US economy still 7 million jobs below pre-pandemic levels, it’s still too early for the Fed to consider slowing down asset purchases.
As the first major economy to emerge from the virus-induced recession, China is expected to settle back into their normal GDP growth trend of 4-5% for the remainder of the year.
Key Market Drivers
The Global Economy Slowly Improves, but the Devil is in the Details
Reopenings within the services sector of the US economy are continuing as vaccination rates approach 50% of the population. Difficulty in finding workers in these travel/leisure industries is now the most acute problem, but wage increases and expiration of extended unemployment benefits should ease labor supply concerns. High savings rates and pent-up consumer demand will continue to drive the economy and force production and manufacturing to catch up to the higher spending.
European economies should emerge this quarter from the double dip recession brought on by their general inability to control the third wave of Covid19 and the resulting lockdowns of important parts of their economies. The UK and the continent as a whole is becoming more efficient in delivering inoculations.
Japan benefits from the strength of their export industries, but their perennially weak consumer spending sector will suffer from the current virus wave which has extended states of emergency in various prefectures. Relatedly, the Tokyo Olympics, expected to be a boon for higher consumer spending, is currently in jeopardy.
Having been the first major economy to emerge from the virus induced recession, China is expected to settle back to their more normal trend GDP growth of 4-5% for the remainder of the year as government officials scale back policy support. Of particular concern is the potential impact of the global onshoring trend on their manufacturing industries.
Strong second quarter earnings growth and continued low rates should prevent any notable decline in US equities and continue to provide a very favorable backdrop for these markets. The recent stalling of interest rate increases in intermediate bonds should allow the growth sectors of the market to catch up to the strong relative performance of the more cyclical sectors.
Outperformance of European equity markets over US equities in May is likely a harbinger of the long-awaited, impending emergence of many of these economies from virus induced lockdowns. The structure of these markets which are more heavily weighted towards the more cyclical and travel related industries is an important factor of what should be continued strong relative performance through the summer.
YTD underperformance of Japanese equities compared to the US and Europe is primarily a function of the slow vaccine rollout. A continued recovery and expansion of the global economy should help drive price increases in export-driven stocks and allow a certain amount of catchup in performance.
With Chinese equities continuing to be challenged by a relatively tighter monetary policy and a strong currency, emerging market equity performance will need to be driven by those markets in Latin America and Asia.
Fixed income market participants are taking the Fed at its word that it will neither taper aggressively nor increase rates in the near term, causing yield increases to stall across the curve over the past few months. While the move higher should resume later this year, we do not expect any sharp spikes.
Economic strength from reopenings and low expected default rates have compressed the interest spread on both investment grade and high yield corporate debt compared to US treasuries. Investor clamoring for higher rates should prevent a notable spread widening, but it appears the high yield sector may not be sufficiently compensating investors for the risk of holding this below investment grade paper. Private debt funds are gaining greater interest as a high yield alternative.
Developed international debt continues to be very expensive with some European countries continuing to trade at negative yields. Any concern about a prospective decrease in central bank bond purchases could put this sector at risk.
Emerging market debt may be a more attractive higher yielding asset class as waning dollar strength and the expected recovery from Covid19 induced lockdowns should attract capital into some Latin American and Asian markets.
Despite various Fed governors calling for the beginning of discussions to withdraw portions of the extreme monetary ease, Chair Powell has consistently reiterated that with jobs still 7 million below pre-pandemic levels, it is still too early to begin considering the slowdown in asset purchases. With any tapering of quantitative easing not expected until late this year/early next and the fed funds rate remaining at effectively zero until early 2023, monetary policy will continue to be supportive of the economy and financial markets. Any resulting inflation will continue to be viewed as temporary and will not be immediately met with monetary tightening.
The European Central Bank and Bank of Japan are even further away from considering asset purchase tapering or rate increases as their economic recoveries are stalled and inflation rates remain below the 2% target. The Bank of England is likely closer to considering some slowdown of asset purchases over the coming months as they only have a price stability mandate. This has been reflected in a notable year to date increase in the pound sterling.
The Peoples Bank of China has already begun a somewhat stealth tightening policy as they push back against rising commodity prices and potential asset bubbles. This has caused enough strength in the renminbi that the central bankers may be forced to pause to prevent a more negative impact on export growth.
The dollar is basically flat year to date against a basket of major currencies. Expect the greenback to trade in a somewhat narrow band around current levels throughout the summer as relative economic strength in the US is offset by fears of higher inflation and growing deficits.
Crude oil prices are being driven higher by recovering global demand and continued discipline in the OPEC+ cartel. While increased supply from US shale producers has yet to develop, we are likely near price points where that incremental production should begin to flow into markets and stop further notable price gains.
Volatility in the cryptocurrency space has likely renewed investor interest in gold as a more preferred alternative store of value and hedge against an increase in inflationary expectations. Further advances in the yellow metal will be predicated on future inflation being more permanent than the central bankers believe at this time.
What This Means for Investors
The global economy continues to slowly recover from the brief, but severe pandemic induced recession. The recovery has been uneven and loose monetary policy remains necessary to ensure its continuation. Inflationary implications will develop, but do not expect many central banks to meaningfully tighten unless and until these price increases are sustained. This remains a favorable environment for equity prices as we do not expect rates to rise meaningfully over the coming months.
For more market insights, contact a Cerity Partners advisor or visit the thought leadership section of ceritypartners.com.
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