Back on track

Global equities had a good week, gaining some 2% in both local currency and sterling terms. They have now recovered the 4-5% losses sustained in mid-April and are back 0.5-1% above their end-March high on both measures.

The rebound has been led by the UK and China. Over the last month, the UK is up around 6% and China as much as 10% whereas the US has risen only 1% and is still languishing a little below its March high. Worst performer of all has been Japan which is down 2% in sterling terms.

The swift market recovery from the April correction has been down to a number of factors.

First, mounting fears that US rates might end up being raised rather than reduced later this year have faded. Fed Chair Powell at their meeting the week before last said rates were unlikely to be raised. In addition, a considerably smaller than expected gain in employment in April soothed concerns that the strength of the economy might prevent any rate cuts.

US Treasury yields have in response unwound some of their move higher in mid-April which had started to exert its toll on equities. 10-year yields are back down to 4.5% from last month’s high of 4.7%

Rate cut hopes have also been bolstered recently in the UK. BOE Governor Bailey last week stated that while more data was needed to be sure inflation was under control again, he was optimistic things were moving in the right direction. More importantly, he didn’t rule out a cut in June and said rates could fall faster than investors expected.

Rates are now set to fall sooner and faster in the UK and Eurozone than in the US. The first cut looks most likely to occur in June in the Eurozone, June or August in the UK, and November in the US.

Sentiment in the UK and Europe has also been boosted by the first quarter GDP numbers which surprised on the upside and showed their economies emerging faster than anticipated from last year’s mild recession. UK GDP grew a larger than expected 0.6% over the quarter, leaving activity in March up 0.7% on a year earlier.

The last factor behind the equity rebound has been the US earnings season which is now drawing to a close. S&P 500 earnings should end up posting a strong underlying gain of close to 10% on a year earlier. More importantly, the Magnificent Seven tech stocks have so far overall met expectations, leading to a recovery in their share prices. That said, the AI poster child Nvidia still has to report on 22 May.

In short, the macro backdrop once again looks reasonably positive for equity markets – particularly those regions where rates are set to be cut sooner rather than later, growth is picking up and valuations remain relatively cheap.  Asia/Emerging markets and the UK remain our favoured areas, along with small and mid-cap stocks which should be the biggest beneficiaries from the upturn in growth and lower interest rates.

As for bonds, returns also look quite attractive. While the extra yield paid by corporate bonds over government bonds is at historically low levels, the macro backdrop should remain supportive, just as it is for equities. Higher quality corporate bonds yield a respectable 5.5% in both the UK and US. And on the back of a modest tailwind from monetary easing, annual returns over the next year or two should be rather higher than this.

Very short term, however, it will be down to the US consumer price data on Tuesday as to whether the recent more positive tone to markets continues or not.

Rupert Thompson – Chief Economist