Economic growth, inflation, earnings — defining the 2021 markets

Did we just get a year’s worth of market movement in a quarter?

If you think (insert any of the *below here) is over, think again. It has only just begun.

*reflation/rising inflation

*rising interest rates

*a steeper yield curve

*the economic re-opening

*the manufacturing boom

*the jobs recovery

*consumer pent-up demand

*revenge/envy spending

*the bull market

A lot has happened in the markets for the first quarter of 2021.  You could ask ‘Did we just get a year’s worth of market movement in a quarter? If so, then what’s left? And if not, then where do we go from here?’ By this, we point to the rapid rise in U.S. Treasury yields (and Canadian yields for that matter), the gains in oil and other commodity prices, and equity market returns. In short, we concluded that no, the year hasn’t been front-ended. In fact, we suggest that while the speed of the market movement was faster than we anticipated, things have progressed directionally, as expected. Markets are merely responding to the improving economic and earnings environment.

Equity markets performed well through the first quarter, extending the gains made since the market lows of March last year. The S&P 500 Index gained 6.2% in U.S. dollar terms (4.9% CAD), including dividends. Gains were prevalent across most major equity indices with the MSCI EAFE Index up 3.6% in U.S. dollar terms (2.32% CAD) and the MSCI Emerging Markets Index returning 2.3% USD (1.1% CAD), both including dividends.

Our expectation of Canadian equity outperformance against U.S. equities for 2021 appears to have materialized through the first quarter as the S&P/TSX Composite Index gained 8.1%, including dividends.  As expected, energy and financials were the second and third-best performing sectors over the quarter, gaining 18.8% and 12.7% respectively, only bested by health care, which gained 37.8%.

Perhaps the biggest surprise to the market was the increase in bond yields. The U.S. 10-year Treasury yield started the year at 0.91% and very quickly rose by 83 basis points to end the quarter at 1.74%. The rise in yields was right in line with the expected 2021 view, however, it happened quicker than expected. The move in U.S. Treasury yields was met by similar movements in Canadian bond yields. The 10-year Government of Canada bond yield gained 88 basis points to finish the quarter at 1.56%. Bond yields rose across several categories. As a result, the FTSE Canadian Universe Bond Index, the benchmark for Canadian bonds, fell 5% during the quarter.

The following is from Manulife Securities Investment Management:

The U.S. Treasury curve has steepened sharply.

Source: Manulife Investment Management, Bloomberg, as of March 31, 2021

Back to the initial question though: “Where do we go from here?” We outline our views in three themes that we believe will define the economic and market environment through the remainder of 2021:

  • Economic growth is set to surge — surprises to economic growth will skew to the upside.
  • Higher inflation is the new norm — yields will continue to follow.
  • Equity market gains will transition from multiple expansion to earnings growth.

Economic growth is set to surge

While countries around the world continue to face new waves of COVID-19 contagion, and lockdowns as a result, we point to some of the recent economic data, which has surprised to the upside, emanating out of the United States for what a full reopen may look like. Last week, for example, the Institute for Supply Management’s Manufacturing Purchasing Managers’ Index (ISM PMI) jumped to 64.7, a level not seen since 1983 (a level above 50 indicates expansion). Additionally, the U.S. Non-farm Payrolls report showed 916,000 jobs were created in the month of March (with an additional 156,000 from revisions to the prior two months), the strongest job gains since last August.

Job gains are starting to reaccelerate.

Source: Manulife Investment Management, Bloomberg, as of March 31, 2021

Some economies, like the United States, have only just started to open up, while others (much of Europe and Canada) remain economically restrained. For example, the combined population of California, Illinois, Massachusetts, and New York is approximately 78.5 million people. These are states that had some of the more stringent lockdowns and are poised to reopen. The recent data, however, would support our thesis from last year that the COVID-19 pandemic is more likely a disruptive even rather than a destructive event. As lockdowns lift, and in line with our rapid reopen thesis, we suggest that the data we’re seeing foretell a surge in economic activity to come.

Higher inflation is the new norm

Our out-of-consensus base case at the start of the year was for inflation, as measured by the U.S. Consumer Price Index (CPI), to accelerate to above 2.5% on a year-over-year basis. We believe January’s 1.4% CPI is the low level for the year. Our inflation model forecasts sustained higher inflation through 2021, with only some moderation in early 2022. The upside risks to inflation remain higher wages (as the travel and hospitality sectors rush to add back staff), continued commodity price pressure (not limited to oil), and higher producer prices.

Evidence of higher inflation is already making its way through the economic data — the ISM PMI Report on Business Prices Index has surged to 85.6, the highest level since 2008. Lumber, one of the biggest costs in home-building after land and labour, has never been more expensive and is more than twice the typical price for this time of year. Crude oil, a starting point for paint, plastics, flooring, etc., has shot up more than 80% since October. Copper, which carries water and electricity, costs about a third more than it did in the autumn. Given the low levels of business inventories combined with the backlog of orders and the potential release of pent-up demand, the direction for inflation is most likely higher, not lower.

The signs of higher inflation are right in front of us.

Source: Manulife Investment Management, Bloomberg, as of March 31, 2021

Higher inflation expectations have led the U.S. 10-year yield to rise above our full-year target of 1.5% before the end of the first quarter. Our out-of-consensus view of inflation led to a similar out-of-consensus view for yields. As the surge in yields has met our initial target, we’ve revised our expectations to 2.0%, with risk to the upside through the remainder of the year. This will continue to pose challenges for fixed-income investors when it comes to long-duration bonds.

Equity market gains will transition from multiple expansion to earnings growth

The optimistic economic outlook leads us to our favourable view towards equity markets. Our research suggests that in an environment characterized by accelerating growth and accelerating inflation, major equity markets tend to perform well — in particular, those that are cyclically oriented or have higher exposure to commodities (e.g., emerging markets, Canada).

Over the past year, equity market returns have largely been driven by valuation, or price-to-earnings (P/E), expansion. This is typical of an equity market recovery following a recessionary bear market. This period is typically characterized by stellar equity gains as the market starts to price in a recovery. For those investors who are concerned with the current market valuation, we suggest that higher equity valuation in the context of higher forthcoming earnings growth (today’s scenario) is less of a concern than higher valuation and low earnings growth (the 2000 tech wreck scenario). The driver of performance tends to shift to earnings growth and is usually marked by a peak in valuation. We should point out, however, that in earnings-driven environments, market returns tend to be positive yet average to below-average. Therefore, investors would be well served to discount the outsized equity market gains over the past year and return to average expectations. However, we believe that the risk is to the upside.

Periods of strong earnings growth tend to moderate valuation.

Source: Manulife Investment Management, Bloomberg, as of March 31, 2021

As we head into first-quarter earnings results, we’ll be watching closely and paying attention to full-year guidance. Our expectation, given the recent economic data, is that earnings risks are to the upside through 2021 and will be the driver of continued market gains.

Fixed-income returns are likely to face continued headwinds of rising longer-term bond yields. While we don’t expect the U.S Federal Reserve to start raising rates this year, and perhaps next, higher inflation and greater confidence in the economic recovery are likely to continue to put upward pressure on yields.

Our view towards equities continues to be positive for the coming 12 months on accelerating earnings growth. Equities are fully valued, perhaps over-valued; however, in the context of much stronger earnings growth, we believe valuation is likely to ease over the coming year, which is typical following equity returns driven by multiple expansions.

Our Growth/Inflation Momentum Matrix would suggest that emerging market equities, Canadian equities (the S&P/TSX Composite Index), and commodities tend to do well in an accelerating growth and accelerating inflationary environment. These are areas that we’ve increased exposure to in the prior two quarters.

Source: Philip Petursson, Chief Investment Strategist and Head of Capital Markets Research

Manulife Investment Management

Nothing to do with markets but interesting nonetheless!

The World’s Top 10 Most Spoken Languages

In today’s increasingly globalized world, having a shared means of communication—or an international language, rather—is more important than ever.  With over 1.1 billion speakers worldwide, English is currently the closest we’ve come to a lingua franca, a common language that connects people from different backgrounds.  However, Mandarin Chinese may one day catch up. Here’s a look at the top 10 most spoken languages across the globe.  While English and Mandarin Chinese come close when looking at their total number of speakers, English has a wider geographical distribution—it’s classified as an official language in 67 different countries worldwide.  In contrast, Mandarin Chinese is recognized as an official language in just five regions.

Things look slightly different when looking at total native speakers, or people who consider a language their first/primary one.  In this instance, Mandarin Chinese and Spanish outrank English.  This begs the question—will English remain the “dominant” language in the years to come, or will the world be switching to a new lingua franca in the future?

Source: Visual Capitalist

Rare Superman Comic Sells For Record $3.25 Million

A rare edition of a comic in which Superman made his first-ever appearance has sold for a record $3.25 million.  It means the issue of Action Comics #1, which sold for 10 cents when it was released in 1938, is the world’s most valuable comic book.  The comic includes the story of Superman’s origins and is considered to be the start of the superhero genre.  It is thought only around 100 copies of the comic still exist.  This particular copy was “buried in a stack of old 1930s movie magazines” and was in mint condition, online auction house said in a statement.  The comic explains how Superman came to earth from another planet and went on to become Clark Kent.  It “really is the beginning of the superhero genre”, said co-owner, Vincent Zurzolo, who brokered the sale. Hundreds of thousands of copies of the magazine were printed in 1938, he added.  The seller made a $1m profit on the comic after owning it for just three years. The anonymous buyer is “relatively new to comic investing”, the statement said.  A different copy of the issue sold for $3.2m on eBay in 2014.

Source: BBC


SPECTRE Breaks Guinness World Record

SPECTRE has been awarded a Guinness World Records™ title for the Largest Film Stunt Explosion. Producer Barbara Broccoli, Daniel Craig and Léa Seydoux, accepted the record certificate in Beijing, China on behalf of winner Chris Corbould, who served as Special Effects and Miniature Effects Supervisor on SPECTRE. The explosion was filmed in Erfoud, Morocco and used 8418 litres of fuel and 33kg of explosives. Commenting on the announcement, Michael G. Wilson and Barbara Broccoli, the producers of SPECTRE, said, “It is absolutely tremendous that the Guinness World Records have recognized Chris Corbould’s incredible work in SPECTRE in which he created the largest explosion ever in film history.”

Source: Paramount Pictures



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