Please see below article received from Legal & General yesterday afternoon, which provides stock market analysis and an update on the progress of global economic recovery.
Economic clock
We increased our medium-term risk-taking view to +1 (on a range of -3 to +3) in December as it became clear that the vaccine rollout would make rapid progress through the first half of 2021. This view is based on three considerations: the economic cycle, valuations, and systemic risk.
We scored the economic cycle at +2 in December, but believe it is now time to downgrade that to +1. This quarter, US output is expected to exceed its pre-pandemic level and we expect it be about 1.5% above its pre-pandemic trend in the fourth quarter. Meanwhile, we forecast about 4% unemployment in the US by the end of the year, just 0.5% above the pre-pandemic level. So, while we expect rapid growth – we are above consensus on that – and markets remain backed by extensive ongoing policy support, we believe the economy will start to run out of easy expansionary space within 12 months.
The valuations dial remains neutral; despite a 10% S&P 500 index return in the year to date, given earnings growth we don’t feel the move is large enough for a downgrade. Relative valuations remain a positive factor too; as an example, while the gap between earnings yields and bond yields has narrowed, it remains well above long-term averages. On absolute valuations, price-to-earnings ratios are similar to June 2020, but we expect earning upgrades and so believe “real” multiples are lower than the headlines suggest.
Finally, on systemic risk we have upgraded from -1 to 0. This reflects the amalgam of factors that have the potential to derail markets and the economy but are impossible to capture through our normal cyclical analysis. Given countries’ limited space for further monetary easing, US-China relations, and Eurozone debt issues, we have been negative on this factor for most of recent history. However, each of the three major economic blocs has shown impressive institutional resilience in the past year: US civil society bent but didn’t buckle in the aftermath of the election, Europe took a (limited) step towards debt mutualisation, and China has navigated the pandemic remarkably well. Institutions have passed a lot of difficult tests.
So, overall, we remain +1 for the medium term, but somewhat more cautious in how we apply that score. We’ll be more prepared to sell into strength while still planning to buy any significant dips.
Off to a flyer
US core CPI’s 0.9% monthly increase in April was easily the largest since the early 1980s and beat expectations by 0.6%. Everybody knew inflation would pick up in the next few months, but this is a much faster jump than expected.
While dramatic, we think it is mainly transitory as re-opening and supply disruptions combine. For example, used-car prices rose 10% in a month and that alone added 0.3%. Airfares and hotels added 0.2% between them too. The stickier elements of inflation like rent, education and healthcare remained more subdued.
There is certainly a case where the inflation momentum continues and becomes self-perpetuating as excess consumer savings, fiscal stimulus and low interest rates drive demand, all supported by lower commodity inventories and chip shortages. A combination of low unemployment and higher prices in 2022 could lead to wage rises that then spiral into higher prices.
That said, there are also structural deflationary forces that have put downward pressure on global inflation over the past decade and those still apply. In particular, we’ve previously outlined technology’s role and also that of globalisation in creating a more flexible labour force with less bargaining power.
There are even arguments that the COVID-19 crisis will intensify those structural deflationary forces; technology adoption has accelerated and remote working has dramatically increased intra-country workforce flexibility.
So, on balance, we don’t expect sustained inflation pressure and are short US inflation to push back on the increasingly positive narrative, with US 5y5y inflation already 0.5% above pre-COVID levels.
Tech tock
It’s been a tough time for tech, with a 10% correction for Nasdaq stocks versus the S&P 500 index since mid-February. This was the biggest relative fall of the past decade, coming after the biggest rise. Inevitably that’s leading to a lot of headlines on inflation as the driver, high tech valuations, and tech being over-loved and vulnerable – a timebomb waiting to go off. We disagree.
We think that rising inflation has been largely coincidental, not causal. There’s no consistent correlation between inflation or bond yields and tech; it’s in the middle of the pack as a sector. Instead, we link tech’s performance more closely to higher economic growth. Technology is perceived as offering secular growth and so is more attractive when growth elsewhere is weak, so now with the recovery other sectors are re-rating relative to tech. As growth momentum (e.g. purchasing managers’ indices) slows, pressure on tech should moderate. For the longer term, there is an argument that tech will do well if there is sustained inflation, as it implies sustained wage pressure which in turn encourages companies to automate and innovate.
On valuations, price-to-earnings ratios are back to pre-COVID levels despite strong earnings. That isn’t outright cheap but corrected any outperformance in excess of what relative earnings have done. We would expect structurally higher future tech growth as the pandemic has permanently shifted attitudes in areas like remote working and consumers’ online habits, in our view.
Finally, on sentiment, recent broker surveys show large moves out of tech. While price action suggests there are still plenty of owners, we are a long way from the extremes seen in the past with sectors like banks preferred on the basis of their higher expected growth in earnings.
We will continue to publish relevant articles and helpful market updates as the UK Government continues to push for mass-vaccination, with people aged 38-39 able to book an appointment from Thursday.
Stay safe.
Chloe
18/05/2021