Markets last week
Mixed data leads to another solid week for equities
A combination of moderate economic data – showing strong but not excessive recoveries across major countries from the pandemic – and relief that inflationary pressures, whilst rising in the short term, are not yet threatening a prices spiral, allowed equities to notch up another solid week. There were gains of just under 1% across most indices with the US typical in its 0.6% rise. This trend was particularly supported by another weaker-than-expected non-farm payrolls number on Friday – for the second month in a row now, and little evidence of anecdotal reports of sharp rises in wages in some sectors translating through into economy-wide pressure on pay. The result was to see equities retain their favoured asset status, underscored by further consideration of a really positive earnings season where increased operational leverage from a year of pandemic-driven cost cutting helped drive better-than-expected profits.
In geographical terms, emerging markets led the way, up 1.5% helped by the solid economic recovery in developed economies, followed by the UK. Hong Kong brought up the rear as continued political uncertainty caused it to lag wider market returns over the week.
This is approaching a goldilocks scenario; where the economy, like the three bears’ porridge, is neither too hot nor too cold, and is good for risky assets like equities. It allowed worries that central banks might revert sooner than expected to their traditional role of taking away the punch bowl just as the party is getting into full swing to abate. Bond yields fell, especially after the non-farm payrolls data, meaning a solid week for fixed interest investors as well. The US 10-year yield fell to 1.55% from 1.59% at the start of the week.
In sectoral terms, this background was good for more economically sensitive and value-oriented areas of the stock market. Driven by a rally in the oil price, the best performance came from energy, up by 5.5%, followed by real estate and materials. The laggards were dominated by more defensive areas and led by healthcare (down 0.6%), followed by utilities and consumer discretionary (where internet retailers like Amazon are found).
Despite last week’s relief rally, it would be a surprise if this were to mark the end of the challenge to bond yield stability. Economic growth is coming through quickly now, and the current level of global monetary stimulus is not sustainable forever in an environment of better news and pressure on inflation. As a result, we still expect bond yields to head higher. At this stage of the cycle, this isn’t bad news for equities as a whole, although it does put pressure on those with the highest valuations. After all, when earnings are scarce investors are prepared to pay a premium for their scarcity. As profits become more widespread, the premium they’re prepared to pay erodes.
The week ahead
Tuesday: National Federation of Independent Business (NFIB) survey, US
Our thoughts: the NFIB Business Optimism survey of some 325,000 small and independent businesses across the entire United States tends to garner a lot of interest because of the breadth of the views it represents in this key job-creating sector.
The measure saw a sharp decline early last year as a result of COVID-19 lockdowns, recovered in the middle portion of 2020 before falling back once more in the face of the second virus wave. Since its recent low of 95 in January 2021 it has progressively recovered to 99.8 in April.
It is expected to rise to around 100.7 in the May release, which is due to be published on Tuesday. There it would be at a relatively normal long-term level, although the index is very sensitive to greater regulation (it shot up to all-time highs of just under 109 after the election of Donald Trump who promised to trash regulations, and languished in the mid-90s during much of the presidency of Barack Obama, who imposed lots of them). Last week, the NFIB highlighted the difficulty in recruiting new staff, with a record high 48% of small business owners reporting unfilled vacancies compared with a near 50-year average of 22%. As such, any indication that the difficulty in filling jobs is hurting output and confidence may well be viewed as a negative, since it implies the need to offer inflation-busting pay increases to attract new workers and retain existing ones. Further evidence of such constraints appeared in the Fed’s Beige Book release this week (see below).
Thursday: the European Central Bank (ECB) meets to set policy rates
Our thoughts: although no-one expects the ECB to change interest rates, with the Deposit Facility Rate stuck at -0.5%, markets will be focused on any comments ECB President Christine Lagarde may make on the future pace of asset purchases and the ECB’s approach to the recent upswing in inflation. With the European recovery lagging somewhat behind those of the US and UK, and even with better progress on the vaccination front, it remains likely that she will eschew the temptation to “talk about talking about tapering” (see central banks section below), but markets are highly sensitive to comments from key central bankers at the moment, and any perceived hawkishness on tapering may prompt 10-year German bund yields to move closer to 0% from their current negative level of -0.21%.
Thursday: US Consumer Price Inflation (CPI)
Our thoughts: the US Federal Reserve focuses on a different measure of inflation (so-called “core personal consumption expenditures”, or PCE). Nonetheless, the official US CPI number will be closely watched for signs that inflationary pressures are getting out of hand. Excluding the volatile energy and food components, the number for April, reported last month, came in at 3.0% year-on-year, and is expected to have risen to 3.4% in May. Including food and energy the number was 4.2% last month and is expected to rise to an eye-watering 4.7% this time. Although Fed officials have made it clear that they expect the current bump in inflation to be transient, and that it is only just appropriate to be even thinking about thinking about tapering, any numbers significantly above expectations are bound to cause markets to fret about an earlier than expected reduction in liquidity, which might push up bond yields and encourage further the recent rotation into more cyclical and value-style equities.
The numbers for the week
|Equity indices (price only)|
|In local currency||In sterling|
|Index||Last week||YTD||Last week||YTD|
|Hong Kong equities||-0.70%||6.20%||-0.40%||2.30%|
|Emerging market equities||1.50%||7.00%||1.80%||3.10%|
|Government bond yields (yield change in basis points)|
|Current level||Last week||YTD|
|10-year US Treasury||1.55%||-4||64|
|10-year German Bund||-0.21%||-3||36|
|Current level||Last week||YTD|
|Commodities (in USD)|
|Current level||Last week||YTD|
|Brent oil (bbl)||71.89||3.20%||38.80%|
|WTI oil (bbl)||69.62||5.00%||43.50%|
|Copper (metric tonne)||9955||-3.00%||28.20%|
Sources: FTSE, Canaccord Genuity Wealth Management
Central banks/fiscal policy
Talking about talking about tapering
There was little central bank action over the week, as we await the interest rate meetings of the ECB in the coming week and the Fed the week after. Most focus fell on comments made in a speech by Fed governor Lael Brainard (seen as a “dove” on the rate-setting Federal Open Markets Committee), which very gently appeared to imply that discussions on tapering would become more appropriate relatively soon. In typical Fed-watcher style, this small shift was based on her use of the word “steady” rather than “patient” in discussing her approach to the current level of monetary accommodation. Divining the import of occasionally cryptic central banker comments often turns on the semantics of such tiny differences in language.
In addition, the Fed released its most recent Beige Book report on economic activity, reporting that the economy expanded overall at a “moderate pace”. Consumer spending picked up as a result of increased coronavirus vaccination rates and manufacturing activity increased despite notable supply chain challenges, despite port activity on the US east coast seen at record levels. Inflation pressures continued to build as both input and selling prices moved higher, and bottlenecks were seen in the labour market, with anecdotal evidence of difficulties in hiring especially in the hospitality sector. Most regions reported that these pressures are expected to abate as the year progresses. This was a relatively benign report, that failed to create additional worries about the pace of inflation, and as such was a relief to markets.
A busy week for data. Surveys remain robust, albeit with some evidence of a slight deceleration in growth from high levels, but the increase in employment lagged expectations
Surveys: the much-watched Institute of Supply Management (ISM) survey for manufacturing came in at 61.2, above expectations and compared with the 60.7 reported in May. The prices paid component came in at 88, a small retreat from the 89.6 in May but still at very high levels. New orders were also strong. Notably, however, the employment component came in at 50.9, some way below expectations of 54.6 and presaging a lower than expected non-farm payrolls number later in the week. The ISM services survey was stronger than expected, however, coming in at 64.0 compared with 62.7 last month. The services sector in the US has benefitted from an earlier and more aggressive reopening of the economy, with an excellent vaccine roll-out and a generally more relaxed stance on social distancing, especially in Republican-led states. The overall trend was repeated in the Markit Purchasing Managers Index, which came in at 62.1 for manufacturing and 70.4 for services, both slightly ahead of strong expectations.
Employment and earnings: after the NFIB and Beige Book references to labour shortages, the ADP Challenger job change data was strong, showing an increase in 978,000 positions compared with expectations of 650,000. However, this is a volatile series, with a poor track record of predicting the official non-farm payroll numbers (NFPR), and so it proved on this occasion. The May NFPR headline number released on Friday was markedly weaker than expected for the second month in a row, coming out at 559,000, which whilst better than the upwards revised 278,000 from April, missed expectations of 675,000 and even more so the rumoured level of 750,000. At the same time, the official unemployment level fell to 5.8% from 6.1%, which was actually better than the expected 5.9%. It appears for the time being that more people have left the labour force, with the participation rate declining to 61.6%. Although down marginally, the broader measure of unemployment (including marginal and temporarily part-time workers) remains very high at 10.2%. There remains a suspicion that the continuing generosity of temporary COVID-19 unemployment benefit payments is discouraging workers from re-entering the workforce. We may therefore see an improvement in employment participation as these payments reduce over the coming months, but this is likely to slow declines in headline unemployment. Encouragingly for those worried about inflation, the level of average hourly earnings increased by just under 2%. Although this was an increase from the previous 1.6% increase, it is still some way beneath the 3% and above seen before the pandemic struck.
Other data releases: there was a raft of other data releases, which in general showed a somewhat softer tone to growth. Although durable goods orders excluding the volatile transportation component rose 1% month-on-month, as expected, the Dallas Fed survey came in weaker than anticipated at 34.9 compared with 37.3 last month, Wards vehicle sales were reported at a 16.99 million annual rate (down from 18.3 million last month and expectations of 17.3 million) and MBA mortgage applications were down 4% week-on-week, reflecting higher mortgage interest rates. There are widening signs of a slowdown in the housing market from super-hot levels.
Very little material data in the week
After the increase in OECD growth forecasts discussed last week, there was little data from the UK. The Markit PMI surveys for manufacturing and services were both strong, at 65.6 and 62.9 respectively, although the former fell back slightly from the previous month’s level. They continue to point to a very strong recovery from the plunge in growth last year.
Elsewhere, the Nationwide house price survey was exceptionally strong, with the index climbing 10.9% compared with last year, much more than expected and compared with an annual rise of 7.1% reported in May. Demand for housing remains strong, with better mortgage availability and a scramble to take advantage of the extended stamp duty holiday driving buyer interest across the country.
As elsewhere, robust survey data and falling unemployment but rising inflation
Surveys: the Markit PMI surveys showed strength in manufacturing and a slight improvement in services – the lag in services in Europe reflects the delayed recovery from the most recent COVID-19 wave, with most economies only now beginning to relax lockdown measures. In Germany and France, manufacturing was ahead of expectations at 64.4 and 59.4 respectively, with services at 52.8 and 56.6. For the eurozone as a whole the numbers came in at 63.1 for manufacturing and 55.2 for services, both ahead of expectations. This slightly weaker trend in services compared with manufacturing was also reflected in EU retail sales, which whilst up 23.9% from a year ago, were still down 3.4% month-on-month in May compared with April, with lockdowns the culprit for the short-term fall.
Unemployment: there was better news on the unemployment front, where the trend remains downwards. Europe as a whole managed to protect its workforce from the full brunt of COVID-19 lockdowns through various furlough and employment-support measures, meaning the recovery seen now is perhaps more muted than in the US. Nonetheless, in Germany unemployment fell to 6%, and in Europe as a whole the rate fell to 8.0% compared with the 8.1% reported for April.
Inflation: following last week’s 10.3% rise in German producer prices, the EU-wide measure came in at a slightly lower increase of 7.6%, still up sharply compared with last month’s 4.3% rise. More importantly, CPI numbers followed the global trend with an increase in Germany of 2.4% year-on-year, and of just over 2.0% for the eurozone as a whole, just breaching the psychologically important ECB-targeted rate. This will be a topic of interest in the post-ECB policy committee press conference in the coming week.
China: survey data held steady last month with the two most widely watched series moving very gently in opposite directions. The official PMI series for manufacturing saw a small decline, to 51.0 from 51.1, offset by a rise in the services series from 54.9 to 55.2. This was enough to see the composite series rise to 54.2 compared with 53.8 last month. On the other hand, the respected Caixin PMI (run by Markit) saw the inverse pattern, with manufacturing slightly up to 52 from 51.9 and services slightly down to 55.1 from 56.3. Overall, this meant the Caixin composite PMI fell to 53.8 compared with 54.7. Whichever of these is more accurate, the underlying picture is one of steady growth in the Chinese economy, with services (now more than 50% of output) performing a little better than manufacturing.
Japan: following last week’s strong machine tool orders data, Japanese industrial production numbers reported for April were slightly disappointing, even if they continue to show a strong bounce-back in activity as companies around the world embark on a capital expenditure splurge. Production rose 2.5% month-on-month against expectations of 3.9%, translating into a 15.4% annual rate, compared with a hoped-for 16.9% level. Meanwhile, whilst a little better than weak expectations, consumer confidence still languished at 34.1 compared with 34.7 the previous month, hurt by an upsurge in COVID-19 infections and lingering doubts about whether the Olympic Games will be able to proceed, despite the assurances of Prime Minister Suga Yoshihide.
Commodity prices were generally mixed over the week. Amongst industrial metals, iron ore was slightly firmer, close to record levels and still above US$200/tonne. On the other hand, copper gave back a little of its recent gains, falling 3% to US$9,955/tonne. In precious metals gold failed to hold onto US$1,900/oz, but only fell back slightly to US$1,892/oz. The week’s standout performance came from oil, where a sensible OPEC+ meeting at which phased and gradual increases in production were reiterated against a background of recovering demand was seen as positive. Brent crude rose 3.2% to US$71.90/barrel.