Global equity markets rallied impressively in the 2nd quarter, pushing some year-to-date numbers into double-digit territory only halfway through the calendar year.The rally was evenly felt across the planet, with the S&P 500 Index up 8.6%, the MSCI EAFE Index up 5.2% (USD), and the MSCI EM Index up 5.1% (USD). For the year-to-date period, the numbers are 15.3%, 8.8%, and 7.4%, respectively. The S&P 500 has increased by over 96% since the pandemic selloff last year due to massive amounts of monetary and fiscal stimulus, optimism on vaccines, and the reopening of the economy. The re-opening or reflation trade, which favors more cyclical, value names – gained steam in the early part of the quarter but reversed course and then some in June. On the quarter, the MSCI ACWI Value Index underperformed its growth counterpart by 5.14%, the reversal was more pronounced in the U.S. with the Russell 1000 Value Index underperforming Russell 1000 Growth Index by 6.72%. (The Standard & Poor’s 500 Index is a capitalization weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries. The Russell 1000 Growth Index measures the performance of those Russell 1000 companies with higher price-to-book ratios and higher forecasted growth values. Russell 1000 Value Index measures the performance of those Russell 1000 companies with lower price-to-book ratios and lower forecasted growth values.) The key reason for the rotation from value stocks to growth was as a result of the US Federal Reserve revealing that it believes that at least two rate hikes will be likely by the end of 2023, as opposed to only initiating the rate hike process in 2024. The US Federal Reserve (Fed’s) response to the global pandemic (lowering interest rates to zero, restarting their quantitative easing program, and launching several lending facilities) helped save the economy from a major recession and was the main driver of the stock market boom over the last fifteen months. Now that the economy is on the path to recovery and inflation pressures are rising, the US Fed must decide when to tighten monetary policy by first taking their foot off the gas pedal (tapering the quantitative easing program) and next by hitting the brake (raising interest rates). The US Fed’s timeline has accelerated in the last few months as both economic growth and inflation have been higher than previously forecast.
One of the bigger surprises of the quarter was the decrease in the US 10-Year Treasury yield. After reaching an all-time low of 0.51% in August 2020, the US 10-Year yield increased to 1.74% at the end of the first quarter before declining to its present level of 1.47%. Long-term interest rates are typically mainly driven by estimates of economic growth and inflation. The drop in the 10-Year was partially due to the decreasing odds of additional major fiscal stimulus bills passing and the market coming around to the idea that inflation may have peaked. The US Fed estimates that inflation will level out to around 2% by 2022. In other words, the US Fed believes US inflation has peaked. Within US interest-bearing markets, investors pursued yield and inflation hedges amidst low sovereign bond yields and higher inflation, favoring US inflation-linked bonds, emerging market debt, as well as European high yield bonds. The hawkish US Fed announcements led to a strong quarter for the USD, with the US Dollar Index rising just under +3% for the month.
In Europe, equity market indices were buoyed over the quarter by consumer and luxury goods companies such as Adidas, Kering, Louis Vuitton Moët Hennessy (LVMH) and L’Oreal. Germany’s DAX rose +0.7% for the month (+7.3% QTD and +13.2% YTD) and France’s CAC concluded June +0.9% higher (+7.4% QTD and +17.2% YTD). In the UK, the economy contracted by -1.6% during the first quarter, but the FTSE 100 Index proved resilient, posting a +0.2% gain for the month (+4.8% QTD and +8.9% YTD). The lifting of all UK restrictions has been delayed from 21 June to 19 July, at which time it is anticipated that life in the UK will start to resemble pre-pandemic normality.
Asian markets have been under pressure, especially in China, where policy tightening and state regulation of large technology companies have raised concern. The Hang Seng fell -1.1% for the month, but is still +5.9% YTD. Oil and iron ore have led the returns on the commodity front, with oil finishing higher in each of the last five quarters after OPEC signaled strong demand amid managed supply – oil price +52% YTD and iron ore +38% YTD. A stronger US dollar and shift to risk-on appetite weighed on gold during June and is now -7% YTD.
On the local front, the JSE All Share TR Index closed almost flat for the second quarter, but posted a +13.2% return year-to-date. Following months of strong performance, financials and mining companies led the overall -2.5% decline of the local bourse during June. While a decline in US yields buoyed the rand early on in the quarter, the US Federal Reserve’s hawkish interest rate outlook resulted in the local unit closing the month lower against most DM currencies. Core inflation clocked in at +3.1% YoY, significantly below the headline rate of +5.2% YoY. This indicates that the prices of food and fuel in particular have risen notably over the period. The petrol price has increased by R5 a litre over the past year, or +40% YoY to reach R17.23 by end of May 2021. Unemployment rose to an unenviable record high of 32.6% in the first quarter of 2021. Most of the job losses were in the construction industry. On a positive note, retailer confidence reached a six-year high of 54 points in the second quarter; up from 37 points the previous quarter. SA GDP grew by an annualised +4.6% in the three months through March from the previous quarter. Output is, however, still down from a year ago with the GDP figure -3.2%. Government announced that companies without a licence to produce its own electricity would be allowed to increase its generation threshold to 100MW. This is supportive of long-term GDP and may alleviate the long-term burden on taxpayers. It was also announced that a majority stake of 51% of South African Airways (SAA) was sold to a private flight operating consortium.
Financial markets will now begin to transition as we have reached peak levels of corporate earnings growth, economic growth, fiscal stimulus, and monetary stimulus. While the absolute levels will remain high, the growth rates will begin to decelerate as we move further away from the pandemic and the economy transitions into a mid-cycle environment. In contrast to last year, global stock market’s (especially US) will face headwinds caused by the economic recovery, including: higher interest rates and inflation (which will weigh on valuations that are already stretched), the possibility that the US Fed may tighten earlier than expected, and the potential for higher US taxes (the Build Back Better plan may include higher corporate, individual, estate, and capital gains taxes).