Johnson and Johnson’s news that the vaccine is effective against the Delta variant should help to allay fears that the world is about to experience a round of upheaval similar to early 2020.
There is no question that the pandemic has acted as an accelerant. It forced migration and adaption to new conditions in a manner that might otherwise never have happened. Whilst consensus seems to be that ‘things have changed forever’, we would anticipate that whilst some developments will stick, human nature being what it is, means that in many walks of life, normal service will ultimately resume.
ASSET ALLOCATION HIGHLIGHTS:
• Vaccine uptake through Q2 was encouraging globally, likely leading to a full re-openings across many countries over the summer.
• Headline inflation ticked up past 3% year-over-year, but both monetary and fiscal stimulus are expected to remain accommodating for markets for quite some time.
• Although the global supply chain remains stretched (e.g. new car production has been held back by a global semiconductor shortage), corporate reporting and economic indicators through the quarter were generally positive and in line with market expectations.
• Global equity markets continue to hit new highs, up roughly 5% in the last quarter, while bond markets saw little movement.
• In Europe, share market performance was also very strong and Europe remains underowned by our lights.
• The MSCI Europe ex UK Index (in local currency) gained +7.1% through the quarter led by Switzerland
• (+10.0%) and France (+8.6%). The MSCI Europe ex UK Index has gained +30.3% over the last 12 months.
KEY MARKET THEMES
Many are looking for deeper, more profound interpretations of what the pandemic means sociologically – a trigger for something, a consequence of something else. Human nature being what it is, and craving contact has not changed, and perhaps we have an even greater need for it in light of lockdowns.
As with every other crisis, the liquidity created to deal with the shock will remain in the system for much longer than it is strictly required. Central banks will not chance jeopardising the recovery they worked so hard to create. Meanwhile, populations everywhere are impatient for better conditions and voter sentiment follows.
It’s that impatience which is likely to translate into government policy and additional deficit spending. Many measures of global deficits are still running at around $1.8 trillion. At least as we stand, with little or no ill consequences of running such massive governmental overdrafts, why would any politician seeking relection run on a balanced budget platform?
Meanwhile the risk is that the precedent is set in bailing out consumers directly is much more comfortable than bailing out banks and businesses. Calls to boost social spending and to increase the scope of support programs will be hot election issues in years to come. Ultimately, all politics is local and focuses on giving the people what they want. The pandemic has changed the way bailouts are practiced. That suggests in future crises we can anticipate a much greater focus on people than businesses.
Globally, we are a lot more vigilant today than we were before the pandemic, and it is unlikely to be repeated anytime soon. All manner of mitigation strategies have been tested and it stands to reason that the responses to a future health scare will be more systematised. That’s also why virus news has been incapable of impacting financial markets for years – global markets are looking beyond the crisis, and perhaps even beyond ‘reopening’.
BETTING ON TRANSITORY
Instead, we are once more floating on a sea of liquidity. US money supply is growing at 16% month over month. That’s nowhere near the peak values from last year but the rate of growth is still outstripping the pace ahead of the pandemic. At the same time short-term interest rates are still close to zero. The result is that financial conditions remain as loose as they have ever been and financial markets should remain well bid.
The yield curve spread (10-year – 3-month) has hit at least a near-term peak. Growth is recovering and investors are betting that inflationary pressures are indeed transitory. That’s resulting in bond yields compressing which is creating demand for higher growth assets, meaning that tech stocks prevalent on the Nasdaq continue to lead the charge.
As has been well publicised, sending cheques in the post to consumers and time on their hands, led to a bull market in retail trading and ‘meme stocks’. It was also a significant influence on the surge in demand for cryptocurrencies in 2020. Cash flowed into these digital assets globally and the sector reached a market cap of $2 trillion.
Bitcoin’s price acceleration in 2020 was driven by institutions offering custody services to large clients chasing similar returns to those experienced by retail investors in 2017. The $10 trillion in additional pandemic money printing spurred significant interest in the sector. It peaked in May and is likely to be a much quieter venue for speculation until about a year before the next halvening. Given that Bitcoin can be seen as a barometer of risk and liquidity it may yet prove a canary in the coal mine for other assets that have been beneficiaries of the money printing, such as those of the more speculative nature being SPACs and companies with no earnings but plenty of promise.
The Dollar remains the lynchpin for flows between the USA and the rest of the world. Despite higher growth and the prospect of the Federal Reserve moving to taper assistance at some point over the coming 18 months, the big question is whether that is enough to support the Dollar. A weakening US Dollar can provide a tailwind for commodities and commodity related assets, and the price action in those markets is painting a similar picture.
For example, the LME Metals Index and CRB Raw Industrial Resources Spot Index both remain in clear uptrends. The Baltic Dry Index, a measure of daily shipping freight rates, also continues to extend its breakout from a long- term range that has previously contained upside price moves. Ultimately, the consumer will feel these pricing pressures which are appearing in the supply chain.
STILL BULLISH STUFF
The resolve of governments all over the world to build back better remains a tailwind for commodity demand growth. Mining stocks have bounced convincingly in the last month, and remain well bid.
One question that markets may ultimately face is much higher oil prices – it seems unlikely that We witness a commodities bull market without oil prices also making new highs, as we saw in the last two big bull markets. However, as we stand there is nothing to suggest that we are on the cusp of a supply shortage for crude oil. The impressive rebound from the 2020 lows has been impressive but is predicated on OPEC+’s supply discipline.
Secular bull markets in commodities are defined by the rising cost of marginal production. Prices breakout when demand increases and supply takes time to respond. That suggests a new oil bull market will not take place until the supply excess for crude has been chipped away and a new source of demand emerges – not to mention the significant capital expenditure devoted to ‘transitionary fuels’ such as biodiesel. However, we do not believe the same ‘excess capacity’ resides in the metals and materials sector. The world is already devoting massive resources to battery manufacturing and development. The refusal to retool to favour platinum over palladium in catalytic converters is a reflection of the lack of investment in internal combustion engines.
The materials sector is bringing down the cost of producing carbon fibre, plastics and innovating to produce long lasting, light weight, strong polymers that are on the cusp of competing with lumber, cement and steel. However, the mega trend which is the ESG movement puts a huge burden on industrial metals, and does likely mean a new significant source of demand.
ASSET CLASS VIEWS
Equities
• One region where there is less talk of tapering is the Eurozone. That has helped the Europe STOXX 600 move up to new 21 year highs which suggests clearer sailing ahead.
• Despite the challenge represented by the delta variant in many Asian countries, the Emerging Asia-Ex China sector continues to outperform.
• India remains a high growth market with the potential for standards of governance to improve over the long-term. We remain long term bulls of India, and the beginning of a new credit cycle which should help to support growth over the coming years.
Bonds
• India remains a high growth market with the potential for standards of governance to improve over the long-term. We remain long term bulls of India, and the beginning of a new credit cycle which should help to support growth over the coming years.
• Of interest was how the US Federal Reserve would react to increasing inflationary pressures. The US consumer price index had been persistently low following the global financial crisis in 2008.
• This year, however, due to the economic resurgence brought about by the reduction in many Covid restrictions, prices have been trending upwards and inflation clocked in at +5% for the year ended May 2021. This was the largest 12 month increase since 2008.
• This announcement caused shorter term yields to spike – the US 2 year yield rose to 0.25% from 0.16%, where it has been sitting since the crisis began.
• The longer term US 10 year yield actually declined from 1.74% to 1.47%, as the notion that above target inflation in the future might be tolerated was quashed in the Federal Reserve’s June update.
Commodities
• Gold remains an attractive asset in an environment where asset price inflation and valuation expansion is predicated on a race to the bottom in the currency market.
• Gold remains in a corrective phase for the last 10 months.
• Silver continues to be range bound, and needs ultimately to move higher above 28 USD to reaffirm the uptrend.
• Any call to accelerate decarbonisation should be positive for the nuclear sector and China’s molten salt reactor is due to come on line in the next month or two, which should help to improve sentiment towards the sector provided it is successful.
Currencies
• The Bank of England is expressing disquiet at rising inflationary pressures but does not appear willing to do anything about it other than talk. The Pound is testing the upper side of its base formation against the Dollar, Yen and Euro.
• On aggregate, there commodity producers and Pound look most likely to trend higher against the Dollar over the medium term.
• The Dollar is competing for the weakest currency crown with Europe and Japan.
• The Australian Dollar, Canadian Dollar, Brazilian Real, South African Rand, Russian Ruble all strengthened in line with commodities over the last year.
CONCLUSION
The investing conditions remain propitious to a continued bull market in commodities, not least the drive to decarbonise. The intermittency of solar and wind where on full display this month with California needing to ration power and asking people to only charge electric vehicles at night. The market for a carbon neutral base load electricity provider remains a secular growth story. In this respect, Uranium is a contender and not least as innovative new reactor models are built and tested.
Hydrogen might be viewed as an energy storage story since the majority of production plans are focusing on renewable energy. Just this week Kazakhstan permissioned a 45 gigawatt project. Since the Asian Renewable Energy hub has run into difficulties with planning, that puts Fortescue’s plans for a project of similar scale (14GW) into jeopardy too.
We continue to see limited cause for concern in stock markets, lead indicators do not portend of any future recessions and supply shortages, years of underinvestment, continued monetary support from central banks, along with fiscal stimulus measures all point to a continuing bull market, led not least by ‘things that hurt when you drop them on your foot’.
