The combination of strong economic data, extraordinary fiscal stimulus, negative real interests and central banks prepared to look through short-term supply pressures supported further gains in risk assets in April. Fixed interest held steady despite rising input prices fuelling inflation fears. UK and international equities returned just over 4% with broad based US indices performing slightly better than average and Asia/emerging markets slightly worse. Japan was the only market to decline as another lockdown took its toll on sentiment. Commodities continued to rally on the demand upturn, inflation expectations and renewed speculation.
China and US continue to be the main contributors to the sharp recovery in global GDP, although the pace will now ease. Estimated global GDP of 5.5% this year and 4.1% next will fade to normal by 2024. The advanced economies’ growth of 4.7% lags emerging markets at 6.6%. Global business surveys remain buoyant although both China’s manufacturing and services headline readings missed expectations in April after a very strong prior month. In manufacturing the large (state-owned) and medium sized companies eased back more than the smaller enterprises. Reports of rising material costs, supply chain disruption and microchip shortage are themes reflected across the global supply chain. The economy is still expanding so we wouldn’t read too much into the slowing pace of manufacturing as other higher frequency data – such as consumer spending associated with the Labour Day holiday – is improving. China is also on track to vaccinate 40% of its 1.4 billion population before July.
The US recovery has accelerated in recent months as high vaccination rates turbo-charge GDP on top of already sizeable fiscal stimulus, negative real interest rates and accommodative monetary conditions. With expectations now raised, not all economic data are surprising on the upside – for example the latest ISM Manufacturing survey – but in absolute terms the numbers are still very strong. So strong that Federal Reserve members have been forced to defend their accommodative stance in the face of rising input prices, which they consider transitory. One key metric is jobs growth which has lagged the recovery so far – reflecting the lingering impact of social distancing on the services sector – but another monthly increase of a million or more would mean the Fed’s adjusted unemployment rate was down to an estimated 7.5%, around half-way to full employment. With economic activity running white hot, it therefore seems likely that ‘tapering’ of asset purchases will be on the agenda at the June Federal Open Markets Committee. We won’t know for sometime whether re-employment will lead to sustained wage growth – as companies reporting labour skill shortages might imply – since the pandemic will have given others an opportunity to restructure and deploy new technologies to reduce labour dependency; US Q1 21 GDP exceeded the equivalent period last year with 8+ million fewer workers.
Japan and Europe lag the strong upturn underway in the US as the result of indecisive lockdown and vaccination policies which have led to a resurgence in Covid-19 and renewed restrictions. Estimates for Japanese GDP growth have been trimmed to 1.6% from 1.9%, delaying a return to pre-pandemic levels into 2022 and even then there may be scope for disappointment given the relative lack of investment – even in software – through the pandemic in contrast to the US where investment in information-processing has grown steadily. The rest of Europe is around two months behind the US and UK with vaccination rollout so the current step-up should significantly boost H2 GDP although there is still some uncertainty over the length of the current third lockdown. Pressure is mounting to reduce restrictions ahead of the critical tourism season, especially important for Spain, Italy and Greece. Fiscal support at around 8% of GDP remains high by European standards with public debt to GDP now just over 100% vs. 85% pre-pandemic. Core inflation in Japan is zero and below 1% in Europe.
The UK is also on track for a sharp recovery in 2021. After a flat Q1, the easing of lockdown restrictions, a successful vaccination programme, further fiscal support – now equivalent to 10% of GDP – could see GDP grow by over 6% this year. Unemployment remains low but while dependency on furlough is reducing sharply full reabsorption may not be quick enough to prevent the rate rising to over 6%. As with other central banks, the Bank of England is prepared to look through the uptick in supply chain prices and therefore the easing bias remains for now.
The huge fiscal response to the pandemic across the developed world was necessary but is likely to have borrowed from future growth as the majority of the monies have not been reinvested in enhancing productive capacity, likely leaving debt burdens higher relative to GDP. Servicing that debt is a challenge for the future but it does imply that central banks have a very strong incentive to keep rates low. In the meantime the extremely favourable financial background means that GDP growth will be well above average for a couple of years. Markets have been worrying about the spike in inflation but unless there is a deliberate change in central bank policy, it seems likely disinflationary conditions will return to the developed economies until the aging demographic’s profile changes.
The best news in recent weeks has come from corporate earnings. Expectations are always carefully crafted and continually adjusted but with just over half of companies reported so far, there have been a record number of beats in what has been a very strong rebound since the low in March 2020. Headline earnings year-on-year were up 50% in both the US and Europe with revenues 11% and 4% higher respectively and little evidence of margin pressures, although widespread microchip shortage has created production backlogs. Materials, energy, consumer discretionary and financials have rebounded the most, having fallen significantly in the pandemic, helping to support the outperformance of cyclical vs. value style stocks since the autumn. The cyclicals vs. defensives trade has come a long way but there is probably further to go in the coming months. Attention has diverted a little from technology and all things digital but the longer-term opportunities remain.