House View, August 2021
Global daily covid-19 cases have increased as the Delta variant has spread, although the impact on developed economies’ recovery should be limited. Our forecast for 2021 world GDP growth is 6.0%.
We continue to see euro area GDP expanding by 4.3% in 2021, although the Delta variant and persistent supply-chain disruptions have increased downside risks. In the US, the year-on-year rise in the consumer price index (to 5.4%) in June could mark a peak, although US headline inflation could stay high for a while due to persistent bottlenecks. The Fed is likely to taper its bond purchases in the coming months, but a rate hike remains distant. We expect 6.5% annual growth in 2021 in the US overall.
The Delta variant could delay the recovery of production capacity in Asia outside China, meaning strong Chinese exports could extend well into H2. Our GDP growth forecast for China this year is 9.0%.
With an exceptional Q2 reporting season soon behind us, the chance of an increase in volatility means we remain on the conservative side on risk assets overall. This tactical caution extends to EM assets given concerns around the coronavirus, China’s regulatory crackdown and US dollar strength. Within developed markets we remain focused on companies with strong balance sheets and pricing power, with companies paying sustainable dividends a further investment theme.
We remain underweight government bonds, with signals from the US Federal Reserve about tapering of its asset purchases a possible focus for a rise in real interest rates. We are underweight euro corporate bonds but neutral their US equivalents, which offer better carry. The post-pandemic focus on clean infrastructure and reducing carbon emissions means these remain ongoing investment themes.
OPEC+’s decision on 18 July to increase production by 0.4 million barrels per day (mbd) each month from August will not be enough to satisfy global demand in H2, expected to increase by 3 mbd (with the spread of the Delta variant seen as having only a mild impact). The rise in oil demand should be more modest in 2022. Oil supply will be helped by OPEC+’s decision to phase out existing production caps by September 2022.
In the short term, risk sentiment could weaken on the back of the spread of the Delta variant, providing some support to the US dollar. Also, based on its most recent forward guidance, we do not expect the ECB to hike rates anytime soon. Yet, a Fed voluntarily behind the curve on inflation and a narrowing of the US economy’s outperformance could soon penalise the US dollar.
Our overall neutral stance on equities has not changed. With forward price-ratio ratios above 21x for the S&P 500 companies and around 16x for the Stoxx Europe 600, equity valuations are high by historical standards. But they are supported by low sovereign yields and by earnings upgrades, with sizeable upward revisions to 2021 and 2022 earnings in the US and to a lesser extent Europe.
The Q2 21 reporting season has also seen strong positive surprises from US companies.
Year-on-year earnings growth is expected to have peaked in Q2, but so far earnings guidance for the rest of the year from a limited number of companies remains supportive. The cyclical recovery in earnings is not over, especially in Europe, explaining the recent outperformance of European cyclical stocks over defensive ones.
Sovereign bonds rallied aggressively on both sides of the Atlantic during July as investors digested increasing Delta variant cases and signs of slowing growth momentum.
The 10-year US Treasury yield fell to 1.13% at one stage, its lowest level in over four months, despite the biggest rise in US inflation in over a decade. The fall in yields would also seem to indicate changing investor confidence in the Federal Reserve’s strategy.
We continue to expect real rates to drive nominal US yields higher, with the Jackson Hole meeting in late August a potential catalyst.
As the pandemic proved, profound market downturns are opportunities for private equity funds to deploy capital on favourable terms, with ‘dry powder’ declining as a rich palette of opportunities has emerged.