Time to Spend?

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Global equities have had a strong couple of weeks, with markets gaining a further 1.8% in local currency terms and 2.8% in sterling terms over the past week. Year to-date, they are now up as much as 9.3% and 7.7% in local and sterling terms respectively.

At the start of the month, this buoyant mood seemed in sync with the start of spring. Now as I stare out of the window at the odd snowflake, I have to fall back on more prosaic fundamentals to explain the cheeriness of markets.

The Federal Reserve has certainly done its best to maintain the market’s bullish mood by reiterating its dovish message. It is saying it will be some time until substantial further progress was made on achieving its full employment and inflation goals – the condition it has set for starting to scale back its QE program.

The Fed is also still not forecasting any rate rise before 2024. Down the road, it could well bring forward its lift-off date and an increase in 2023 is quite possible. However, following the marked rise in Treasury yields over the last two months, the markets are now pricing in as many as three rate hikes that year. This looks excessive and helps explain why yields have stabilised in recent weeks, easing worries that the bond sell-off might de-rail equity markets.

The IMF has just released its latest world economic outlook which was relatively optimistic. Its forecast for global growth has been raised to 6.6% and 4.4% for this year and next, with the US accounting for the lion’s share of the upward revision on the back of the large fiscal stimulus.

Equally important, the IMF now believes that Covid-19 should cause considerably less long-term damage to the world economy than the global financial crisis. Emerging economies with the exception of China are expected to come off worst but somewhat incredibly, US GDP is now forecast to be higher in three years’ time than the IMF had been forecasting pre-covid.

Hopes of a strong rebound in the global economy are reflected in the 30% gain in corporate earnings now expected for the world this year. Estimates have been revised up substantially since last summer and the US has been the driving force. Earnings in each of the last three quarters have ended up beating expectations by as much as 10-15%.

This Wednesday will see the big US banks kick off the first quarter reporting season. The consensus expects US earnings to be up a hefty 25% on a year earlier. The market’s focus, however, as ever will be on company guidance for the rest of the year as much as results for the quarter just gone.

We believe the medium-term outlook for equities remains positive and prospective returns remain significantly higher than for bonds. That said, equity markets have risen a long way and are now pricing in quite a lot of good news and at a minimum a pause looks overdue.

Fed Chair Jerome Powell last week said the US economy is at an inflection point with growth and hiring set to accelerate. But he also admitted the pandemic still poses risks and that new surges of Covid-19 could impede the recovery.

Here in the UK, the rapid vaccine roll-out and sharp fall in infections is clearly reassuring. Even so, the speed of the forthcoming recovery remains uncertain.

UK individuals are on course to have accumulated an extra £180bn (or some 9% of GDP) in their bank accounts since the pandemic began. However, it is far from clear to what extent people will spend this pile of cash, particularly as these savings have been built up by wealthier individuals who are rather less likely to go out and spend it. Still, a chilly outdoor meal and drink at a pub might be looking rather tempting.

Rupert Thompson

Chief Investment Officer