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The good, the bad and the ugly largely portray the current market dynamics. Not associating to the well-known western movie produced in 1966, markets are being conditioned by three factors which selectively might be less benevolent in the near future.
The ‘good’ factor is the fact that global immunization is surely a positive which markets have cheered all the way since the vaccine discovery in the early days of November. Despite disparity in terms of immunization is clearly visible, developed nations vis-à-vis developing nations, we can’t ignore the fact that many countries have taken serious steps in achieving respectable levels of immunity. A step which has enabled countries to lessen the harsh restrictive measures and ultimately enable the global economy to reassume its recovery path. Indeed over the past couple of months we have seen some strong economic data which might have excited way too much market participants. Nevertheless, the positive trend is data turned to be emphatic following a year in which uncertainty prevailed. Inevitably the base effect is one of the factors and this is why going forward monitoring of predominately leading indicators is key.
Moreover within the ‘good’ factor context, markets also applauded the unconditional support by both fiscal and monetary politicians. To date, major central banks continued to show their support by reiterating that their accommodative stance will last until their main target that of price stability, amongst others, will be fulfilled. In reality, in the short-term, as a market participant, such support is well accepted. However, from an economic sustainability perspective, this is a huge concern in the medium to long term and eventually all this support will pose risks. Clearly at the current juncture, bad news is good news, as markets are comforted by the reassurances put forward by namely central banks.
The ‘bad factor’ is the resurgence of covid cases. Following a controlled situation in the first quarter of the month, namely in the developed world, covid cases have spiked following the emergence of the delta variant-a variant which is much more infectious and now scientifically proven that it can also be transmitted to those vaccinated. Putting you into the ‘bad’ practical context, the spike in cases has once again triggered a negative impact on economic growth globally. Clearly as a market participant, value trades which we believed were a clear opportunity prior to the emergence of the delta variant, might now take longer to materialize. Case in point, expectations on the travel sector have changed ever since.
However, looking at broader picture with a more positive tone, realistically speaking the impact would not be as dramatic as the initial wave of COVID-19 because economies have learned to adapt to lockdowns and other tools utilized to control the spread of the pandemic. Nonetheless, as we’ve seen over the past months selective emerging market economies would likely be hit hardest due to relatively limited health care infrastructure as well as lower vaccination levels.
The ‘ugly’ factor which markets might need to embrace going forward is the impromptu decisions being taken by the Chinese governments which clearly are triggering remarkable market volatility in selective sectors. Undoubtedly, these dictatorial measures do not augur well for the foreseeable future as their unpredictability will continue to increase the political risk within the region. Thus not surprised that on a year-to-date basis, the Chinese equity market is amongst the few negative performers despite its relatively strong fundamental attractiveness.
A longer shot, and this could be the ugliest bit, are the up roaring tensions between China versus the U.S., Europe and lately the U.K. The latest draconian measures taken by the Chinese government, mainly in relation to Hong Kong, continued to triggered uneasiness amongst mainly the two world largest economies. As opposed to the view that Biden’s administration might be more diplomatic, clearly to date this is not the case even when considering the latest frictions at very early stages in discussions between diplomats for the possible first meeting between the two Presidents later on this year. Undoubtedly, these tensions do not augur well and this would be a real threat going forward. As we have experienced in 2018, such tensions can create severe consequences for the global economy given the importance of the two supra-nations.
Our base case since late February was that economies will accelerate as we shift towards a more tangible normalization path, and that inflation will ultimately result into a transitory phase rather than sustained namely in the U.S. That said, the latter is yet to be tested as consumer spending trends need to be monitored. However, the United States has had a very effective vaccine rollout and is likely to take the lead in the global economic recovery. as growth in China moderates. The UK and eurozone are likely to follow the US recovery, with emerging markets countries generally lagging behind because of the obstacles they face vaccinating their respective populations. As economies reopen and spending increases, inflation should rise significantly, especially in the US as the Fed expects, but we anticipate that levels will normalize. That said, the possible unpredictable tensions might weigh negatively market sentiment.
Constructively speaking, in the short-term, overall we remain cautiously optimistic on equities, as we believe that the reassurances by leading central banks will continue to be supportive, despite fundamentally we might be in a weaker position than many market participants believe. Namely retail liquidity is triggering market noise and the remarkable intra-day swings are a clear example of such phenomena. We also hold a positive outlook for the high yield space, given its low volatility mainly in Europe and the as yet accommodative stance by leading central banks. Interesting times ahead, be picky through a fundamental approach is key for long-term success.
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