A selection of articles looking back through the markets last month.
Global Market Review
Markets gripped by inflation fears
Although global equity markets generally ended May in positive territory, investor sentiment during the month was affected by growing concerns that mounting inflationary pressures could lead to higher interest rates.
“The shadow of Covid-19 is beginning to lift from Europe’s economy”
In the US, the rate of consumer price inflation increased from 2.6% to 4.2% year on year during April, rising at its most rapid rate since September 2008. Prices were stoked by a 10% increase in the cost of used cars and trucks, and further flattered by last year’s sharp Covid-induced decline. Investors’ concerns were compounded by a warning from US Treasury Secretary Janet Yellen that interest rates might have to rise “somewhat” in order to prevent the economy from overheating. The Dow Jones Industrial Average Index rose by 1.9% over May as a whole.
The European Commission raised its forecast for economic growth in the eurozone to 4.2% this year and 4.4% next year, encouraged by strengthening momentum in Europe’s vaccine rollout programme. EU Commissioner Paolo Gentiloni commented: “The shadow of Covid-19 is beginning to lift from Europe’s economy. After a weak start to the year, we project strong growth in both 2021 and 2022”. Inflation is predicted to strengthen to 1.7% in 2021, easing to 1.3% in 2022. In comparison, the European Central Bank’s (ECB’s) inflation target still stands at “below, but close to, 2%”. Over May, the benchmark Dax Index climbed by 1.9%.
The UK’s annualised rate of consumer price inflation surged during April from 0.7% to 1.5%, stoked by a sharp increase in the cost of household utilities and clothing. The Bank of England (BoE) expects inflation to reach 2.5% at the end of this year, after which it is forecast to subside to 2% in 2022 and 2023. Meanwhile, the BoE predicts that the UK economy will expand at its most rapid rate since the Second World War this year, boosted by strong consumer demand and a successful vaccine programme. The FTSE 100 Index rose by 0.8% during May.
Japan’s economy contracted by 5.1% during the first quarter of 2021, fuelling worries that the country could be at risk of a double-dip recession. Sentiment was also affected by concerns over the outlook for the impending Tokyo Olympic Games, which were postponed from last year. The Nikkei 225 Index edged 0.2% higher over the month.
Asia & Japan Market Review
Is Japan heading for a double-dip recession?
Share prices in Japan delivered a muted performance during May as investors digested lacklustre economic data alongside concerns over the prospects for the approaching Tokyo Olympic Games. Japan’s authorities imposed a state of emergency in nine prefectures across the country, including Tokyo and Osaka. Over May, the Nikkei 225 Index crept 0.2% higher, the broader-based Topix Index rose by 1.3%, and the TSE Second Section Index edged up 0.1%.
“Low vaccination rates and rising waves of infection are undermining economic recovery”
Japan’s economy shrank at an annualised rate of 5.1% during the first three months of the year, stoking concerns that the country could be moving towards a double-dip recession. The contraction was fuelled by a 1.4% decline in private consumption as coronavirus shutdowns took their toll on activity. Having risen by 11.7% in the final three months of 2020, exports rose by only 2.3% during the first quarter of 2021.
In contrast, Japanese exports surged in Japan during April, rising at an annualised rate of 38%. Shipments to China climbed by almost 34%, while exports to India rose by 183% over the period. Meanwhile, exports to the USA and the EU increased by 45% and 39.5% respectively. Although the figures were flattered by last year’s Covid-related drop in trade, demand for cars, car parts, and electronic components was strong. Imports rose by 12.8% over the period.
During May, South Korea’s central bank upgraded its economic growth forecast to 4% in 2021 and 3% in 2022, encouraged by an increase in export activity and facilities investment. Inflation is expected to reach 1.8% this year and 1.4% next year, compared with the Bank of Korea’s (BoK’s) target of 2%. Central bank policymakers maintained the BoK’s key interest rate at its record low of 0.5%, citing a buoyant export market, improvements in domestic consumption, the strengthening global economic recovery, and widespread government stimulus measures. The Kospi Index rose by 1.8% over the month.
Low vaccination rates and rising waves of infection are undermining economic recovery in many countries in the region, according to IHS Markit. Alongside Japan, several countries in the region – including Malaysia, Thailand, Vietnam, Singapore, and the Philippines – are experiencing Covid-related lockdowns that are hampering activity. Looking ahead, IHS Markit warns that the near-term recovery of many Asian economies is likely to diverge significantly from that of the US and Western European countries, which are already opening up.
Emerging Markets Review
Covid hampers emerging Asia’s recovery
Although China’s strong economy recovery is helping to support developing economies across Asia, lockdown-related restrictions are reducing domestic demand in many economies, delaying their ability to recover at a time when the US, UK, and European economies are rebounding. According to IHS Markit, surging infection rates in India are likely to continue to affect economic activity; several Indian ports have had to reduce operations because of lockdowns and staff shortages, disrupting supply chains and export activity. In particular, IHS Markit has highlighted the broader societal impact of Covid-19 in low-income countries. The World Bank estimates that around 150 million people around the world fell back into “extreme poverty” in 2020, with around 75 million in India.
“There are still signs of unevenness in China’s recovery”
Credit ratings agency Moody’s downgraded its forecast for India’s economic growth this year from 13.7% to 9.3%, citing the impact of the second wave of Covid-19 infections, which is expected to hold back recovery and increase the risk of longer-term economic scarring. Nevertheless, the CNX Nifty Index rose by 6.5% over May.
China’s exports soared during April at an annualised rate of 32.3%, underpinned by strong overseas demand for electronics and medical equipment, while imports surged by 43.1% year on year. Producer prices rose by 6.8% year on year, following a 4.4% increase in March, stoked by higher costs for mining and raw materials. The news fuelled concerns about inflationary pressures. Nonetheless, there are still signs of unevenness in China’s recovery: the rate of growth in China’s industrial production eased in April to 9.8% year on year, compared with March’s rise of 14.1%. Elsewhere, although growth in retail sales was strong at 17.7% in April, it was slower than March’s surge of 34.2%. The Shanghai Composite Index increased by 4.9% over the month.
Having previously raised the Selic rate from 2% to 2.75% in March, policymakers at Brazil’s central bank implemented another 75 basis point increase in May to take its key interest rate to 3.5%. The move was designed to curb gathering inflationary pressures. Brazil’s rate of consumer price inflation rose from 6.17% in April to 7.72% in May, compared with the central bank’s target rate of 3.75% with a tolerance band of 1.5 percentage points on either side. Central bank officials intend to impose another 75 basis point increase in June. During May, the Bovespa Index rose by 6.2%.
Europe Market Review
European growth set to accelerate
Following the easing of lockdown measures, the eurozone is experiencing its strongest surge in demand for goods and services in almost 15 years. However, companies are struggling to keep up with demand, and the imbalance between demand and supply is driving up prices at a rate last seen in 2002. According to IHS Markit, average input prices rose at their fastest pace since March 2011 during May, and growth in services sector costs also accelerated.
“After a weak start to the year, we project strong growth in both 2021 and 2022”
While the manufacturing sector is leading the recovery and expanding at a “near record pace”, activity in the services sector has also surged. Although the rate of job creation continued to run close to its highest level in around two years, it eased slightly in response to difficulties in filling job vacancies. Looking ahead, the data indicate a “sharp acceleration” in economic growth in the region during the second quarter. During May, Germany’s Dax Index rose by 1.9% while France’s CAC 40 Index climbed by 2.8%.
As the rollout of Europe’s Covid-19 vaccination programme continued to gain momentum, the European Commission increased its forecast for economic growth in the eurozone to 4.2% this year and 4.4% next year. EU Commissioner Paolo Gentiloni commented: “The shadow of Covid-19 is beginning to lift from Europe’s economy. After a weak start to the year, we project strong growth in both 2021 and 2022”. Nevertheless, he also warned that, although a premature withdrawal of policy support could jeopardise the region’s economic recovery, a delayed withdrawal could create market distortions and prop up otherwise “unviable” companies. Inflation is forecast to increase to 1.7% in 2021 before moderating to 1.3% in 2022. In comparison, the European Central Bank’s (ECB’s) inflation target currently remains at “below, but close to, 2%”.
Germany’s economy suffered a significantly greater contraction during the first quarter of the year than the wider eurozone, according to data from Destatis. The German economy shrank at an annualised rate of 3.1% during the first three months of 2021, and by 1.8% quarter on quarter, whereas the eurozone’s economy contracted by 1.8% and 0.6% respectively. Household spending in Germany posted a drop of 5.4% over the quarter and the savings ratio climbed to 23.2% as Covid-19 restrictions prevented consumers from spending. Exports rose by 1.8% and imports increased by 3.8%.
Global Bond Market Review
Where next for monetary policy?
During May, European Central Bank (ECB) Vice President Luis de Guindos warned that recent increases in US bond yields had revived concerns over the potential for shifts in financial conditions, which could affect indebted companies, households, sovereigns, and investors who have become more exposed to duration, credit, and liquidity risk. Many investment funds, insurers and pension funds in the euro area are exposed to a further increase in yields or a correction in credit markets. Looking ahead, the ECB is likely to act in the event of an unwarranted rise in yields.
“The ECB is likely to act in the event of an unwarranted rise in yields”
The European Commission raised its economic growth forecast for the eurozone to 4.2% in 2021 and 4.4% in 2022. EU Commissioner Paolo Gentiloni commented: “After a weak start to the year, we project strong growth in both 2021 and 2022”. The prospect that Europe’s economic recovery might be gaining traction fuelled speculation that the benchmark German bond yield might move out of negative territory after more than two years. Its yield rose to -0.08% during May – its highest level for over two years – as investors considered the possibility that the ECB might ease the pace of its asset purchase programme.
In the US, the rate of consumer price inflation rose by 4.2% year on year in April, posting its fastest annualised increase since 2008, while the personal consumption index surged to 3.1%. Nevertheless, the US Federal Reserve (Fed) continues to insist that this inflationary uptick is “transitory”, caused by factors including supply chain disruption and the impact of massive fiscal stimulus. During May, US Treasury Secretary Janet Yellen – previously Chair of the Federal Open Market Committee (FOMC) – warned: “It may be that interest rates will have to rise somewhat”, but subsequently tempered her remarks, saying: “It’s not something I’m predicting or recommending”. The ten-year US Treasury bond yield eased from 1.65% to 1.58% over May as a whole, but rose as high as 1.69% during the month.
Demand for bond funds remained robust during April, according to the Investment Association (IA), and fixed income enjoyed £1.3 billion-worth of inflows during the month. UK Gilts experienced net retail inflows of £255.5 million in April, while inflows into the UK Index-Linked Gilts sector more than doubled over the month. Meanwhile, the Global Inflation-Linked Bond sector saw inflows of almost £94 million.
UK Bond Market Review
Economic recovery boosts inflation
The annualised rate of UK inflation surged during April from 0.7% to 1.5%, stoked by a sharp appreciation in the cost of household utilities and clothing. Although the rise had been widely anticipated, it fuelled concerns that higher costs could persuade central banks to increase interest rates more quickly than predicted. The Bank of England (BoE) expects the rate of consumer price inflation to reach 2.5% at the end of this year, after which it is forecast to subside to 2%. The ten-year UK gilt yield eased from 0.84% to 0.80% over April but rose as high as 0.90% during the month.
“Concerns over rising prices fuelled investors’ appetite for inflation-linked investments”
As concerns over rising prices fuelled investors’ appetite for inflation-linked investments, the Debt Management Office (DMO) reported that the launch of a new index-linked gilt had raised a record £6.1 billion during May. The new bond – which matures in 2039 – had a nominal value of £4 billion.
The BoE expects the UK economy to expand at its most rapid rate since the Second World War this year, boosted by strong consumer demand and a successful vaccine rollout. Following 2020’s record contraction in GDP, the central bank predicts that the UK economy will rebound by 7.25% in 2021. BoE policymakers believe that weakness in the labour market will be far less pronounced than previously feared, and unemployment is now expected to increase “only slightly”. Nevertheless, the BoE emphasised that the evolution of the Covid-19 pandemic remains uncertain, and the Monetary Policy Committee (MPC) does not intend to tighten interest rates until there is “clear evidence” of a sustainable recovery.
Although the UK economy contracted at by 1.5% during the first three months of 2021, it expanded by 2.1% during the month of March, buoyed by the stronger retail activity and the reopening of schools. The rate of unemployment eased to 4.8% over the three months to March, and the number of UK job vacancies rose to 657,000, reaching their highest level since the same period in 2020.
The Confederation of British Industry (CBI) reported that UK manufacturing output posted its fastest rate of growth since December 2018, with activity increasing in 12 of 17 subsectors, including chemicals, electronic engineering, and metal products. Manufacturers believe activity will accelerate further over the next three months; nevertheless, their optimism has been tempered by the expectation of rising cost pressures.
UK Equity Market Review
Signs of building inflationary pressures
Non-essential shops reopened in April and retail sales rose sharply in April, climbing by 9.2% from March. In particular, clothing sales rose by 69.4% over the month. Nevertheless, the British Retail Consortium (BRC) warned that demand remains “fragile”; footfall remains 40% below pre-pandemic levels and 530,000 retail workers remain on furlough. High-street fashion retailer Next increased its full-year earnings forecast but warned that the post-lockdown surge in sales was attributable to pent-up demand and was therefore likely to prove “short-lived”. The FTSE 100 Index and the FTSE 250 Index both ended May 0.8% higher.
“The key, policy-wise, will be to ensure this boom does not turn to bust” (Andy Haldane; BoE)
The Organisation for Economic Co-operation & Development (OECD) upgraded its forecast for UK economic growth to 7.2% but warned that increased border costs following Brexit are likely to affect foreign trade; the OECD believes a closer trade relationship with the EU would improve the economic outlook in the medium term. The OECD called on the UK Government to maintain its support until economic recovery is “firmly under way” but urged it to focus its resources on companies and sectors with the strongest growth prospects.
The level of government borrowing eased in April compared with March as the economy reopened, although it was still the second-highest April on record at £31.7 billion.
UK listed companies issued their lowest number of first-quarter profit warnings for 21 years according to EY. As economic growth recovered, businesses successfully met or exceeded profit targets that had been “dramatically” cut by the Covid-19 pandemic. As a result, only 50 profit warnings were issued during the first three months of 2021, compared with 301 in the same period of 2020. The top FTSE sectors to experience profit warnings during the first three months of 2021 were retailers with eight warnings, and travel & leisure with five warnings.
In an article written for the Daily Mail, the BoE’s Chief Economist Andy Haldane sounded an optimistic note for the UK economy, saying: “A year from now, it is realistic to expect UK growth to be in double-digits, activity to be comfortably above pre-Covid levels and unemployment to be falling”. Nevertheless, he sounded a note of caution, warning: “The key, policy-wise, will be to ensure this boom does not turn to bust. The most likely cause of such a bust, history tells us, is an unwanted bout of inflation.”
UK Equity Income Market Review
UK dividends show signs of a pickup
Having breached 7,000 points for the first time since February 2020 during April, the FTSE 100 Index rose above 7,000 once again during May amid intensifying optimism over the strength of the economic recovery. Business activity surged in the UK during May, according to IHS Markit/CIPS, which commented: “The UK is enjoying an unprecedented growth spurt as the economy reopens”. However, costs continued to surge: as demand outstripped supply, prices rose sharply, and IHS Markit warned that inflation could have “much further to rise”.
“57% of UK companies cut their dividend payouts over the 12 months to the end of March”
The FTSE 100 Index rose by 0.8% over May, and by 8.7% since the start of the year. Meanwhile, the FTSE 250 Index posted a monthly increase of 0.8% and a year-to-date rise of 10.7%. The FTSE 100 Index’s yield eased from 3.08% to 3.00% during May, while the FTSE 250 Index’s yield remained unchanged at 1.85%. In comparison, the yield on the benchmark UK gilt ended May at 0.80%.
During May, FTSE 100 insurer Aviva announced that it aims to make a “substantial return of capital to shareholders” once it has completed a programme of disposals. Elsewhere, drinks manufacturer AG Barr intends to reinstate its dividend in the current financial year.
UK dividend payouts fell by 26.7% during the first quarter of 2021 compared with the same period in 2020, according to Janus Henderson’s Global Dividend Index, which found that 57% of UK companies cut their dividend payouts over the 12 months to the end of March. Over the period, Shell – previously the largest dividend payer in the world – cut its payment by two-thirds; nevertheless, Janus Henderson believes that many formerly large payers would take the opportunity to reset payments to a “more sustainable level”. Over the first three months of 2021, less than half of UK companies in the study cut their dividends, and the headline total for the UK increased by 8.1%, boosted by substantial special dividends from Tesco and BHP.
Equities were the most popular asset class during April, according to the Investment Association (IA), and the UK Smaller Companies sector experienced its strongest inflows since its record £279 million in December 2019. In comparison, investors’ appetite for funds in the mainstream UK All Companies sector dropped sharply following a strong surge in March, and demand for funds in the UK Equity Income sector remained weak.
US Market Review
Fed plays down inflationary concerns
The future trajectory of inflation was the principal factor preoccupying investors in the US during May following the news that the rate of consumer price inflation had risen at its fastest rate since September 2008, climbing from 2.6% to 4.2% year on year . Price increases were fueled not only by a 10% rise in the cost of used vehicles, but also in comparison with 2020’s numbers, which were negatively affected by the onset of the coronavirus pandemic.
“I never said … that climbing out of the deep, deep hole our economy was in would be simple”
The news fueled speculation that interest rates might have to rise more rapidly than previously anticipated, and this speculation was compounded by a warning from US Treasury Secretary Janet Yellen that rates might have to rise “somewhat” in order to prevent the economy from overheating. Nevertheless, Vice Chair of the Federal Reserve (Fed) Richard Clarida maintained that it would be “some time” before the Fed is likely to consider tightening monetary policy.
During May, the Dow Jones Industrial Average Index rose by 1.9%, while the S&P 500 Index climbed by 0.5%. In contrast, the Nasdaq Index fell by 1.5% over the month as investors in technology companies – which tend to be relatively sensitive to signs of inflationary pressure – reacted to concerns over rising prices.
Meanwhile, minutes from April’s meeting of the Federal Open Market Committee (FOMC) suggested that officials believe that much of the increase in prices and consumption can be ascribed to “transitory factors” such as temporary bottlenecks in supply chains, huge fiscal stimulus, and a recovery in prices that had been particularly hard-hit by the pandemic.
Elsewhere, having risen by 1.9% in March, personal consumption surged by 3.1% year on year during April, fuelling concerns that the recovery might be at risk of overheating. At the same time, personal income declined by 13.1% during April after jumping by 20.9% in March in response to government stimulus payments.
Despite President Biden’s massive stimulus measures, only 266,000 new jobs were added to the US economy during April following an increase of 770,000 in March. The rate of unemployment rose from 6.0% to 6.1%, and 9.8 million people remained out of work. Nevertheless, President Biden maintained that the economy was “moving in the right direction” and insisted: “I never said … that climbing out of the deep, deep hole our economy was in would be simple, easy, immediate, or perfectly studied”.