Please see the below article from Legal and General’s Asset Allocation team received late yesterday afternoon:
With some of the lockdown rules easing in England today, and following some recent warm and sunny weather, it feels like change is in the air. In this week’s Key Beliefs, we look at three areas of the market where change may also be on the way.
A deluge of EU doses?
We try not to talk too much about the vaccines and virus now, as it’s increasingly important we focus on other factors. That said, vaccines have featured more heavily in our recent debates and in the market’s commentary.
In the UK, about 60% of adults have had their first jab. In the US, it’s nearly 50% and 25% of adults are fully vaccinated. While there are still risks to reopening in both cases, the likelihood is that the vaccinations will win out in the race against another viral wave.
Inevitably then, there’s a lot of attention on the European Union, where only about 25% of adults have received their initial vaccine dose. It was inevitable that the more infectious variant that was first identified in the UK would become the dominant strain across the continent, and unfortunately that’s led to further lockdowns, so the question is when Europe will be able to reopen.
The good news is that despite the disappointing progress so far, the EU is poised to accelerate rapidly and will likely be two months or fewer behind on its journey. Alongside some more surprising stories, like Bavaria buying the Sputnik V vaccine, the past fortnight has brought the highest vaccination rates yet at 1.5-2% a week. Germany has now outlined its potential to vaccinate 12.5% of its population a week once the supplies are available; Martin Dietz estimates German deliveries at 16.6 million doses in April across four different vaccine providers.
To catch the US up over two months, the EU would need to vaccinate about 4.5% of the population a week. Given the diversified sources of supply Europe is employing, that looks very achievable. So, on balance, Europe could be another source of positive surprises this quarter. We believe this is supportive of both our travel and leisure equity position and broader positive equity view.
High and dry
Market activity tends to be low in the week following Easter, and similarly there was just one view change from our team last week. That came in US Treasuries, where we removed the tactical short position that was designed to help protect us from the risk of a bumper employment number on Good Friday.
After nearly a million US jobs were added in March, we expect further good news as the country reopens. While that supports our medium-term positive equity view, we’re not convinced it implies higher bond yields. There are two main reasons why.
First, with a 10-year yield around 1.65%, we think valuations are towards the upper end of a fair range and that markets will struggle to price in a much higher path, with almost four rate hikes implied in the market consensus by the end of 2023.
Second, we know being short US Treasuries is a very popular position; we try to avoid such crowds, so we prefer to keep our powder dry.
The biggest risk to yields in the coming months may be the upcoming inflation numbers. Starting from depressed levels this time last year, economists already expect temporarily high prints in the second quarter.
However, with so many unusual factors – including the large build-up of household savings – there is a chance that there are big surprises. Last week, we saw the Producer Price Index rise 1% against a consensus expectation of 0.5%. While it’s a noisy series, it could be the first of many.
That said, for the longer term we don’t buy into the idea that there’ll be sustained inflation and are prepared to look through the short-term noise.
The calm after the storm
Uncertainty is high this year, which makes our mantra of ‘prepare, don’t predict’ all the more important. To take one example, sentiment towards equities has been positive for most of the year, but not stretched to levels where it becomes a worrying sign.
However, one of the indicators that Lars Kreckel finds most reliable, the AAII Bull-Bear Spread, has now jumped to 36.5 and is close to the 40+ level that he considers a warning signal. The most recent Goldman Sachs QuickPoll suggests sentiment is a lot less elevated, though.
Against the improving backdrop, we’ve also seen implied volatility in equities drop markedly over the past couple of weeks, with the VIX at its lowest level since February 2020 and broadly in line with average levels from 2018-2019.
So with some evidence that investors are becoming more bullish, we retain our positive equity view, although following strong performance we rebalance to avoid weights drifting up further. Some portfolios have also been selling volatility at elevated levels as a source of return, but we expect those opportunities will be increasingly hard to find.
Please keep checking back for our regularly updated blog content covering a range of market updates and insights from a number of great fund managers, as well as topical issues such as ESG and our own thoughts and input.
Andrew Lloyd
13/04/2021