Equities continued their strong run last week with global markets gaining a further 0.8% to be up 10.7% since the start of the year.
The US reporting season got off to a good start, with the big banks reporting stellar results on the back of strong trading and advisory revenues. Earnings of US financial companies are now forecast in the first quarter to be up over 100% on a year earlier.
For the S&P 500, the key US equity index, the market now expects earnings growth of 30%, up from 25% only a week ago. Just as importantly, earnings estimates for the remainder of this year are also being revised up.
The strong news from the US has not been limited just to earnings. Retail sales posted a gain of just under 10% in March on the back of the re-opening of the economy and also no doubt the $1400 stimulus cheques most Americans will now have received through the post.
Coming months will see very strong growth numbers across much of the world as the economies reopen. China, however, is the major exception. It is already past the peak rebound in growth with the authorities now at the margin taking action to dampen rather than boost activity.
Last week’s numbers showed Chinese GDP in the first quarter up as much as 18.4% on a year earlier. But the gain compared to the previous quarter was a much more meagre 0.6%. Even so, growth over the year as a whole should still be close to 9%, higher than any other major economy with the exception of India.
The global economic rebound is starting to be seen not just in the growth numbers but also in inflation. Headline US inflation jumped in March from 1.7% to 2.6% and the core measure, which strips out volatile food and energy prices, rose from 1.3% to 1.6%.
A further marked increase in inflation is certain to be seen over the next couple of months. This may well cause some jitteriness in markets, even though the Fed insists it will look through any such rise believing it to be largely temporary.
Government bond markets have for the moment calmed down after their bout of hysteria earlier in the year. 10-year US Treasury yields have fallen back 0.20% from their high in March of 1.77%. This in turn has eased fears that the sell-off in bonds was getting out of control and could de-rail the equity market rally.
Almost certainly, bond yields will in due course resume their upward trend. Still, we don’t expect the speed or size of the move to be large enough to cause too much of a problem for equities while earnings growth is strong and surprising to the upside.
Within equities, at least until a few weeks ago, the big story since November has been the rotation away from the expensive high ‘growth’ areas, which were the big winners last year, to the cheaper more cyclical ‘value’ areas. The energy, materials and financial sectors have all outperformed significantly.
The fall back in bond yields has led to the rotation unwinding a little this month but we expect this reversal to be only temporary. The combination of a strong economic rebound, a renewed upward trend in yields and a still unusually large valuation gap between growth and value stocks should lead to a resumption of the move in favour of value.
The UK continues to stand out as one of the cheapest markets and should benefit from this trend. While UK equities have outperformed in recent months, they have so far only reversed a small part of their pronounced underperformance in previous years and still have considerable catch-up potential.
Chief Investment Officer