Global equities gained 4.2% in April (MSCI AC World index in US dollar terms), with a variety of factors underpinning the rise: accelerating COVID-19 vaccination rollouts; confirmation of the US economy recovering with the help of massive fiscal support; and strong earnings reports.
Concerns such as the devastating wave of COVID cases and deaths in India, a Q1 contraction in eurozone GDP, the lingering pace of vaccinations in Europe, and signs of upward inflation pressures remained mostly in the background.
After falling for most of the first quarter, US government bond prices rallied in April, driving the yield on the 10-year T-note yield down to 1.63% and reversing part of the jump from around 0.90% at the end of 2020 to almost 1.75% at the end of March.
Economic indicators confirmed the acceleration in activity. GDP growth was 6.4% (annualised) for the first quarter, just slightly below market expectations calling for 6.7% (according to the Bloomberg consensus). The sprint from the 4.3% Q4 2020 pace was the result of a 10.7% increase in private consumption (+23.6% for goods; +4.6% for services).
GDP is now only 0.9% below the pre-pandemic Q4 2019 level and is expected to rise rapidly to above that level.
April’s survey data pointed to pressures from supply constraints in commodities and electronic components, but also higher transportation costs. These factors are now likely to weigh on bond prices after they drew support from long-term investors (pension funds) benefiting from the rise in yields in the first quarter to reposition themselves at the long end of the yield curve.
Purchases by non-resident investors also supported bonds in April.
Some observers appeared only partly convinced by the US Federal Reserve’s dovish comments on the prospects for higher inflation and on the need for interest rate increases, perhaps sooner that the central bank itself had indicated. For now, however, it looks more likely that we will see a pause after the rapid rise in long-term yields. This suggests that the current downtrend in yields may not last.
After hovering at around -0.30% until mid-April, the German 10-year Bund yield rose to end the month at -0.20%, up by 9bp from the end of March.
Relative to the US market, eurozone bonds underperformed despite the fact that eurozone GDP contracted in Q1 (-0.6% after -0.7% in Q4 2020), while the US economy grew vigorously.
Investors looked beyond the double-dip recession, paying more attention to April’s positive activity surveys and the acceleration of vaccination campaigns after a laborious start. They have begun to position themselves more clearly for a cyclical recovery in the eurozone.
Upward revisions by several governments of their budget deficits for 2021 suggest more bond issues in the second half. This may have contributed to the upward pressure on long-term bond yields.
Lingering doubts over the swift implementation of the Next Generation EU stimulus plan fuelled investor nervousness and caused often erratic intraday moves in government bonds.
In addition, statements by some members of the ECB’s governing council suggested a slightly less accommodative stance than that voiced by ECB President Christine Lagarde. The comments included hints that the pace of asset purchases by the central bank could slow in the face of signs of an improvement in the business climate and the prospect of economies reopening.
The global recovery is firming up. Despite the dramatic scenes in India, progress on vaccination in many countries is reassuring investors that many economies can reopen before the summer.
At the same time, there are signs that inflation is firming, but in developed economies, this should be transitory. It has not been a source of concern for the main central banks.
Investors now anticipate solid growth in the US, but worry that higher long-term rates could weigh on equities and their high valuations. However, a strengthening recovery should make for an improving earnings outlook, justifying the valuations. We believe this setup favours equities over the medium term.
In the shorter term, a correction is possible. The catalysts include the uncertainty over the exact nature of the planned personal and corporate tax rises in the US, a delay in the execution of the Next Generation EU plan, the risk of unanchored inflationary expectations, and a sharp rise in long-term bond yields.
Any sell-off should be viewed as a buying opportunity given the still accommodative monetary policies, extensive government fiscal stimulus and strong fundamentals.
Any views expressed here are those of the author as of the date of publication, are based on available information, and are subject to change without notice. Individual portfolio management teams may hold different views and may take different investment decisions for different clients. This document does not constitute investment advice.
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