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MARKET OVERVIEW

Q2 2021
Over the second quarter, equities rose as vaccination campaigns continued to accelerate in most developed economies, especially in Europe, which is now catching up with the UK and the US. Emerging economies continued to lag on the vaccination front, but cases remain low in China and seem to have peaked in India. 10-year Treasury yields dropped by 30 bps, falling to 1.45%, with the decline helping “growth” stocks to outperform “value” stocks.

Governments in most developed markets continued to ease Covid-related mobility restrictions, which has helped facilitate an uptick in activity levels. Economic data over the last three months has generally been strong, especially in the US, which posted an annualised growth rate of 6.4% in the first quarter. Although the eurozone economy contracted by 0.6% in the first quarter, leading economic indicators, such as purchasing managers’ index (PMI) business surveys, have reached multi-year highs in many regions. These indicators point to a strong economic rebound having taken place in Europe in the second quarter, which should translate into better annualised growth rates.
 

We continue to believe that global growth will remain resilient in the second half of the year, however, the reopening of economies and the quick rebound in activity that has followed has fuelled inflation in some countries. In May, the US consumer price index increased by 5.0% year on year, although some of the underlying details suggest that there are temporary factors at play, such as the rise in used car prices. Whether or not inflation is transitory is one of the biggest questions facing investors right now, and although the Federal Reserve continues to see this inflation increase as transient, it has become slightly more hawkish in its language, acknowledging that tapering is being discussed. The median Federal Open Market Committee participant also now expects two rate hikes sometime in 2023, up from no rate hikes just three months ago. 

At a regional level, the S&P 500 delivered robust returns last quarter, thanks to the rebound of growth stocks, strong first-quarter earnings growth, and the prospect of more fiscal stimulus as Joe Biden reached a bipartisan deal to boost infrastructure spending by USD 600 billion. European & UK stocks followed closely, supported by the reopening of regional economies and strong global goods demand. Meanwhile, policy tightening, and regulatory concerns have weighed on China’s relative performance and on Asian indices as a whole.
 

While the spread of the delta variant is a potential concern, as it could slow the full reopening of economies, the increasing number of cases has so far not led to significantly higher hospital admissions in the UK, who are seen as a “bellwether”, due to their successful vaccine rollout. This suggests that the vaccines work well against the variant and have helped keep deaths at a much lower level, in comparison to previous “waves” of Covid. 

Within fixed income markets, investors searched for yield and inflation hedges against a backdrop of low sovereign bond yields and higher inflation, turning to assets such as emerging market debt, US investment grade credit, and US and European high yield, as well as inflation-linked bonds. In terms of duration, the US outperformed last quarter as investors appeared to prefer relatively higher Treasury yields to still deeply negative real European core sovereign bond yields. In addition, the issuance of EUR 20 billion of 10-year bonds to fund the European Union’s NextGenerationEU recovery package probably also helped to push European core yields slightly higher.
CONCLUSION

In conclusion, we think the outlook for near-term global growth remains strong. As the bounce from pent-up consumer spending fades, we expect government and business spending to pick up the baton. While the second half of the year could be bumpier for financial markets, we still expect equity markets to continue their upward path. Inflation worries are likely to contribute to market jitters, but it will take a lot of bad news to shift the central banks towards a more rapid withdrawal of easy money. Cyclical stocks have outperformed growth stocks so far this year and we believe this rotation has room to run if bond yields rise from here.

We also believe that the recent underperformance of Asia and China, due to worries over policy tightening and vaccine progress, is temporary and that the structural case for Emerging Asia remains intact. Given the increased will to tackle climate change, the 2021 United Nations Climate Change Conference in November is likely to produce a raft of policy, regulation, and investment announcements, creating winners and losers within portfolios.

Finally, we expect more volatility in coming months, not only for equity markets but also for fixed income markets. The role of fixed income in portfolios is currently being challenged, and investors should seek to diversify their global bond holdings and look to alternatives such as gold & property, for solutions. 

Our portfolios were up between 4.5-6.5% for the quarter, net of fees, depending on the currency and risk profile. In our multi-asset portfolios, we are overweight high yielding credit and cash, neutral on equities and underweight developed market fixed income. As mentioned in our Q1 review, although we are overweight to cyclical sectors, we maintained an appropriate equity diversification across all of our portfolios. Thus, a large portion of our equity holdings are still in sectors such as healthcare, consumer discretionary and consumer staples, which helped our portfolios in Q2. Although equity leadership changed hands on a relative basis in Q2 from cyclicals to growth, we will continue to keep our overweight allocation to cyclical sectors and regions, with a focus on “quality” characteristics within this space. There is currently a clamour to bucket equity holdings within “value” or “growth”, however we think this is an oversimplification of the nuanced environment that exists within financial markets and using ratios and subjective formulae to attach a company to a particular style is not telling the whole story.

Across all of our equity holdings, we will continue to invest in good companies that have strong fundamentals and tilt our exposure depending on where we are in the cycle, and the prevailing macro environment. Thus, as economies continue to open, rates rise, curves steepen and inflation creeps back, we feel that some companies that have more cyclical characteristics will benefit. With the expectation of volatility in the coming months, our approach is targeted, and focused on specific areas of the market that will continue to provide durable features for our client’s portfolios.
 
Sources: Morningstar Direct, JP Morgan Asset Management


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