NN IP: Soaring cyclicals, shortage of chips
NN IP: Soaring cyclicals, shortage of chips
Economic data continue to reflect a steady recovery in countries where vaccinations are slowing growth in coronavirus infections and hospitalizations. The easing of mobility restrictions and the positive impact on confidence levels are the key drivers of the recovery. Fiscal stimulus, particularly in the US, is helping consumer spending. For the medium term, more public investments in physical and soft infrastructure should sustain a higher pace of economic growth and create an environment in which private investment growth will move higher.
The improving outlook for fixed investments and the brighter global growth picture overall have been reflected in the strong equity market performance over the past months. More recently, we see increasing evidence of cyclical excitement in commodity markets, where industrial metals have performed particularly well. This is primarily due to the better demand outlook for the short-to-medium term, driven by the re-openings of economies worldwide, and for the longer-term, when US investments in infrastructure and housing will gain pace and the global electrification trend will likely accelerate.
Supply-related concerns for specific metals such as copper are pushing up prices. In Chile, the world’s largest copper exporter, new legislation will require mining companies to pay higher royalties. And in Peru, the second-largest copper producer, presidential front-runner Pedro Castillo’s radical economic plan also includes higher royalties and even expropriation of mining companies. The South American nation holds the second electoral round on 6 June.
The rally in global goods trade that began in the third quarter of last year is showing little signs of abating. Last week’s manufacturing PMIs were strong almost everywhere, with particularly new export orders showing an improved momentum. In Asia, only the Philippines and South Korea recorded a decline in the overall manufacturing PMI and in the new export orders subcomponent. The pandemic must have played a role, although in South Korea’s case, the decline was modest and the index remained well above the neutral 50-mark.
As confirmation that the Korean manufacturing sector continues to benefit from the strong global goods demand, we should mention the Korean export growth momentum, which accelerated remarkably in the first ten days of May. The country remains well-positioned to benefit from the global recovery and more specifically from the strong demand for electronics and semiconductor chips.
Near-term inflation outlook will keep upward pressure on bond yields
A shortage of chips and other supply constraints have caused some renewed worries about the inflation outlook. Our view has not changed much. We think that the fiscal stimulus will sustain strong post-pandemic growth recovery in the US, which will keep pushing headline inflation higher in the coming months. We think it is too early to believe in sustainably higher inflation, beyond the possible overshoot that the Fed is targeting. We would first need to see a substantial improvement in workers’ bargaining power, leading to structurally higher wage growth. The new labour laws being prepared by the Biden administration are hopeful, but their passage and implementation remains highly uncertain.
For now, we think that the short-to-medium-term inflation outlook will keep upward pressure on US bond yields. In our multi-asset model portfolio, we are maintaining our moderate underweight in US Treasuries. The longer-term inflation and rate uncertainty is consistent with current market expectations of the Fed starting to taper QE in 2022 and hiking rates in 2023. Treasury yields dropped by more than 10 bps last Friday, when US payrolls data came out far below expectations. However, markets quickly came to terms with the inherent volatility of these numbers in the current economic recovery phase, and by the end of the day, yields were close to their pre-report levels. In our view, the recovery still looks strong enough to sustain upward pressure on yields, and only a large, unexpected shock will push them materially lower from current levels.
In the Eurozone, rates markets have undergone a more aggressive repricing. While US Treasury yields remained relatively stable around 1.60% in the past weeks, German Bund yields have kept a clear upward momentum. Their 16 bps rise since the beginning of April is the result of investors discounting the improving virus developments and relaxation of mobility restrictions. As macro data continue to confirm a steady recovery, interest rates might overshoot. Meanwhile, the implications of the EU recovery fund and the ECB policy on growth remain unclear. This is the main reason we are keeping a neutral position in Bunds for now.
Our moderate portfolio still includes a moderate overweight in equities and large overweights in crude oil and high-yield credit. Strong pent-up demand in the US and Europe will continue to reduce oil inventories, and favourable refinery demand should continue to outpace OPEC+’s gradual supply return scheduled for the coming three months.
We hold on to our moderate overweight in global equities despite some increased risk aversion in the IT sector related to the semiconductor shortages. The main reasons are the post-pandemic recovery as well as strong corporate fundamentals, which were reflected in a very strong Q1 earnings season. Companies beat expectations by 25%, and positive corporate guidance for the coming quarters has again pushed full-year estimates higher. Global earnings are now expected to grow by 33% in 2021. Europe is leading the pack with estimates exceeding 45%. One of the main risks is supply chain shortages. The chip shortage, for instance, has affected car production and more industries could be affected, which may impact corporate margins in the current quarter.
Within equities, we still prefer value over growth. Two factors play a key role here. First is the strong rise in cyclical commodity prices that is pushing up energy and materials stocks. Food prices are rising sharply, which may become a problem for emerging markets, where food represents a large part of the CPI basket. More broadly, the overall rise in commodity prices is feeding through into inflation expectations. This is raising some question marks for the monetary policy outlook and is keeping upward pressure on bond yields.
The second factor helping value over growth is rising bond yields, which directly support the profitability of financials, the biggest value sector. In addition to our moderate overweight in value stocks over growth stocks, we also overweight cyclicals over defensives, although we have reduced this position in the past month.