Investment Environment May 2021

07.06.21

COVID-19 vaccination progress

The number of vaccines administered worldwide has accelerated since the end of February.  86 mil doses were administered at the end of January, 241 mil at the end of February, 574 mil at the end of March 1.2 bil at the end of April and 1.7 bil at the end of May as shown in the graph.  Significant progress has been made but there remains a long way to go given the approx. 8 billion people in the world.

The progress in rolling out the vaccine has allowed governments to lift some restrictions and we have seen a considerable rebound in economic activity. Both of these data points continue to provide support for a “risk on” environment, although we are mindful that the vaccine success is very much in the developed world and the emerging markets need to catch up – most importantly India.

The IMF has produced GDP forecasts as shown in the graph for 2021 and 2022 that exceed the long term average since 1980 by a considerable margin. It is often argued that this is because of the base effect of negative GDP growth in 2020 caused by Covid, but that is not entirely true. The positive GDP growth must still be achieved as is shown by world trade volumes. China produced a 1Q2021 GDP growth rate of >18%.

The positive GDP growth has flowed through to commodity prices and this is also reflected in the share prices of miners which were relatively undervalued.

There has been a strong rebound in GDP in the US primarily led by consumer spending followed by Government spending.  This spending has been boosted by the various significant fiscal support and monetary stimulus injected into the economy over the past 12 months.

Fiscal stimulus, interest rates and risk free rate

Last month we spoke about the upwards movement in the US Treasury curve from 3 years out and the effect it is having on valuation of financial assets.  This has moderated and marginally decreased in May as shown in the graph. The fear of inflation, and the potential for interest rate rises is the biggest risk to financial markets. However, this is now a consensus view and well commented on by policy makers (eg Powell / the Fed) and should be “in the price”.

Equities

Indices performance (rolling cumulative five year returns in USD):

All indices, with the exception of Technology, were up in May as actual company earnings continue to surprise and the threat of a long time rise in inflation dissipates.  The standout indices performance  for the month were Europe (4.3%) and the UK (3.7%) as a recovery in “value” related stocks improves together with a strengthening of the Euro and Sterling against the USD.  The S&P500 remains the best performing index over a 3 and 5 year period with technology and healthcare being the largest drivers of out-performance.  Emerging markets has been the best performing index over a 1 Yr period.

Earnings & Valuations

S&P500

Last month we commented on the probability of Qtr1 2021 actual earnings outperforming analyst forecasts.  The table shows that growth in actual earnings has outperformed growth in forecasted earnings by 119% (end of April > 80%) (i.e. 51.9% versus 23.7%), which continues to support the rebound in the economy and the bullish prospects for equities.  It should be noted that the actual growth rates per sector is broad based with some sectors outperforming others.

Full year 2021: Earnings growth is forecasted to increase by 33.5% (previously 25.7% ) meaning an upward revision as economies rebound and visibility on economic activity continues to improve.

From a valuation perspective, the S&P500 is trading at 21.2 times 1YF earnings which is above its 5 year average (18x) and 10 year average (16x).  Whilst the S&P500 appears fully priced, the fiscal and monetary stimulus, coupled with historically low interest rates and a rebound in global trade, continues to support equities and a “risk on” environment.

Since the beginning of the year, we have introduced a number of longer term investment themes into the portfolios where applicable and suitable for the client mandate.  We continue to believe in maintaining our technology and healthcare exposures through the S&P500 and supplementing this with specific ETF’s to increase these weightings in the overall portfolio.  In addition, we have added a Clean Energy ETF, Lithium ETF and Metals and Mining ETF to gain exposure to a number of growth plans announced by Governments around the world.  Two of these plans include (source: HSBC Private Banking): 1) American Jobs Plan - $582 bil for Transportation infrastructure and electric vehicles; $561 bil for Green Housing, schools, power and water upgrades; $400 bil for Elderly and disability care; and $165 bil for Broadband and Job  training and 2) EU recovery plan – Multiannual Financial Framework totaling Eur1.07 tril and Next Generation EU Fund totaling Eur750 bil.

Conclusion

Global equity markets continue to perform admirably for the time being as the world rebounds off its lows of a year ago.  Supportive fiscal and monetary stimulus coupled with zero interest rates provide for a “risk on” environment in support of equities.  Corporate earnings have not disappointed and have surprised on the upside.

In South Africa, the strength of the ZAR has not entirely been a surprise given that commodity driven economies typically benefit from large and sustained commodity cycles.  The demand for commodities over the past year has been nothing short of remarkable and is starting to show signs of a longer term super-cycle.  We still remain concerned about South Africa’s ability to implement structural reforms required to drive growth, employment and tax revenue.  The mining and agricultural sectors have displayed good growth but the broader economy (retail, manufacturing, banking, etc.) continues to battle from the effects of COVID 19 and the slow roll out of our vaccine program.  The IMF has revised its forecast for 2021 to 3.1%.

For now equity investors can be cautiously optimistic.

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