Already 2021 has seen a major shift in the landscape of the global macroeconomic picture.
According to Deutsche Bank, financial markets had a pretty mixed performance in the first quarter, with the gains concentrated among risk assets including equities, oil and high yield credit, as progress on the vaccine rollout and the prospect of further stimulus in the US ‘proved supportive’.
In a reversal of 2020 however, safe havens have struggled against this backdrop. Gold has been the worst-performing asset in the DB main sample with sovereign bonds also losing ground over the quarter.
Talk of deflation, Covid-19-inspired slumps and negative in test rates have now been filed firmly in the draw marked 2020, with a new set of worries now centred on growth, inflation and rising bond yields.
Many commentators see those trends accelerating over the next three months as lockdowns ease in some places such as the UK and US, though as France’s recent tightening has illustrated, there is no certainty on how the pandemic will pan out even now.
Inflation is one of the topics that is not going away according to Berenberg, though it sees pricing pressure rising modestly over 2021 before really coming to the fore in 2022.
Inflationary expectations are rising in anticipation of these mounting pressures and are approximately 2.4%.
“Business operating costs are rising, reflecting higher costs of materials and energy, and in some sectors, increases in wages amid (selectively) tight labor markets.
The good news says Berenberg is that thus far is that there is little evidence of product prices rising.
“If aggregate demand remains strong following its surge as the economy reopens, as we expect, businesses will have flexibility to raise product prices and maintain margins.”
Bond yields are going up with inflation expectations.
US ten-year Treasuries are now yielding 1.7%, which is close to pre-pandemic levels, but might rise significantly more suggests Berenberg as inflation expectations pick up.
“We expect the Fed to emphasize that this rise in inflation is temporary,” said the broker, but amid a significantly strengthening economy, will financial markets agree with the Fed’s assessment, the broker asks.
Goldman Sachs sees the yield at 1.9% by the end of 2021, while TD Securities expects yields to rise to 2%.
According to the most recent Bank of America fund manager survey, a 2% yield on the 10-year Treasury could trigger a sell-off in stocks.
The US dollar has risen In tandem with bond yields and is now at its highest level against a basket of currencies for almost 18 months.
That will impact on commodity and mining stocks, especially if the knock-on effect is a further sell-off in gold which is traditionally on the other end of a seesaw with the US currency. Copper and iron ore might also be affected.
Value in vogue again
Tech shares have had a bumpy ride over the past three months and not just Deliveroo (LON:DOO), with some of the stalwarts of the economy picking up over the first quarter in a switch to cyclical or economy -led businesses.
The Russell 1000 value index rose 11% in the first quarter against its growth counterpart’s gain of 1%.
“If a new paradigm emerges, consisting of sustainably higher nominal growth and higher yields, the value trade could run for years,” said Mark Haefele, chief investment officer at UBS Global Wealth Management, in a recent note.
Morgan Stanley this week said the pharma sector stood out as it now trades at a rare price-to-earnings discount to the wider market.
In a note to clients, the bank also said was screening for other defensives with reasonable valuations including UK-listed stocks Tesco (LON:TSCO), Smith & Nephew (LON:SN.), Coca Cola HBC (LON:CCH) and SSE (LON:SSE).
What qualifies as a defensive stock today probably wouldn’t have 20 years ago and vice versa.
So, for example, Vodafone (LON:VOD) is a former rocket stock whose growth is now so pedestrian and predictable it qualifies as a defensive investment.
The supermarket groups, by contrast, have largely lost this cachet due to structural changes affecting the high street, and shopping malls.