Despite growing worries about post-pandemic inflation and the danger of a bubble, stock markets appear impervious to warnings from the sceptics. Where it was the technology and home entertainment sectors that surged during last year’s lockdowns, investors are now betting on cyclicals, commodities and banking to boom in a turbo-charged economic recovery.
Government and central bank stimulus, together with vaccination programmes, have given markets a shot of confidence, and even when there’s bad news, investors are rotating through the different market sectors rather than heading for safe havens. This could spell danger to come – the Fed has warned that markets are vulnerable to “significant declines” should risk appetites falter.
At Dynasty, we remain concerned that equity markets are borrowing returns from the future and that performances will be more subdued going forward. Look at data from Leuthold Group that compares prices today to their average levels since 1995. Plotted against metrics like sales and earnings, the S&P 500 may fall as much as 37% should it revert to its mean. Although this is not our base case scenario, our mantra is to stick to our quality investment strategy where the predictability of future earnings streams and company valuations is more certain than those of cyclical businesses, irrespective of the economic environment.
“No matter what, we’ve seen the market predominantly go up, not down. The market overall is still saying, we believe in the business recovery and we’re still betting on it.”
– Susan Schmidt, head of U.S. equities at Aviva Investors
“[Businesses] face both cyclical and secular challenges. We are constantly forced to examine what businesses are likely to thrive a decade from now and those that can be shuttered. I’m talking about the businesses and not the stock prices, which are a secondary consideration.”
– Steve Romick, Portfolio Manager at First Pacific Advisors
- Economists at the Bank of America have warned that investors are pricing in the risk of a “significant overshoot” of the Federal Reserve’s 2% inflation target for the first time in years. They indicate that the breakeven inflation rate – the difference between nominal and real Treasury yields – is now at its highest level since before the 2013 taper tantrum.
- Another inflation warning came from Stanlib, which said US inflation could remain uncomfortably high for an extended period. US consumer inflation climbed much more than expected in April 2021 to 4.2% year-on-year with core inflation up at 3%.
- Despite the inflationary pressures, the latest hiring numbers in the US disappointed investors and punctured concerns that the economy might overheat as it recovers from the Covid-19 crisis. Employers added just 266,000 workers last month, far short of economists’ expectations of an increase of nearly 1 million new positions.
- Corporations in the US are pushing back against President Biden’s plans to pay for an infrastructure renewal drive via corporate tax hikes. In private talks with business leaders, Biden’s administration is selling the president’s $2.3 trillion infrastructure proposal as an investment that will benefit businesses. Some are proposing alternative ways to fund infrastructure projects.
- In Australia, the Federal Budget shows a stronger than expected economic recovery from the Covid-19 recession with a budget deficit of $161 billion, $52.7 billion lower than the government’s expected deficit. The Budget includes measures to support businesses and individuals with job creation, incentives, tax relief and superannuation changes.
- After the oil supply glut during the pandemic, supplies are back to near-normal levels, according to the International Energy Agency. The IEA has, however, cut its 2021 global demand growth forecast by 270,000 barrels to 5.4 million barrels a day.
- On the subject of commodities, copper, steel and aluminium, are hitting or approaching record highs this year. The Bloomberg Commodity Spot Index jumped to its highest since 2011, with metals up 21% so far this year. Should the rally turn into a super cycle, rising car prices could stoke inflation across the board.
- In other news from the auto industry, Tesla’s Elon Musk said the electric-car maker manufacturer is suspending purchases using Bitcoin. This triggered a slide in the price of Bitcoin.
- On commercial property in the UK, a judge has ruled that Virgin Active can wipe out the rent arrears on most of its venues and avoid future steep payments. With this precedent, we can expect other commercial tenants to seek relief in their debt pile. This development, together with the acceleration in online shopping and remote working, reinforces our post-Covid concerns around the listed property sector in general.
- Echoing global concerns, the JSE fell the most in four weeks on Tuesday as surging commodity prices raised concern about inflation amid signs of economic recovery.
- The South African Reserve Bank’s trade-weighted rand, benchmarked against a basket of 13 currencies, suggests that the rand’s performance has more to do with dollar-weakness than rand strength. The dollar can be expected to regain ground in the coming weeks as economic data improves, implying a slightly weaker rand/dollar exchange rate.
- The Dynasty Investment Committee Currency Model calculates that, by default, South African-specific factors are currently attributing around R1,11 to rand strength against the dollar. We do not believe this is justified or sustainable given the country’s insufficient growth and high levels of debt. The rand remains vulnerable to both South African political and economic shocks and the vagaries of international markets.
- Prosus NV plans to raise its stake in Naspers to nearly 50% in a share swap deal that will move part of its holding in China’s Tencent to Amsterdam from Johannesburg. Naspers accounts for nearly a quarter of the total value of tradeable JSE equities. The proportion had dropped after the Prosus deal, but climbed because of Naspers’ outperformance. The new proposal will drop the Naspers’ JSE weighting down to 14%. Analysts, however, are not necessarily confident that this transaction will unlock the discount at which the group is trading relative to the underlying value of its Tencent investment. The Daily Maverick has an analysis.
- South African automotive components exports increased to a record R54.5 billion in 2020 from R53.7 billion in 2019. This increase is due largely to massive catalytic converter exports of R26 billion, mostly to Europe.
- Dynasty’s primary consulting political analyst, Professor Ivor Sarakinsky, recently expressed his views about the suspension of Ace Magashule. Oliver Dickson, a political analyst, policy and political risk consultant, also offers an interesting perspective. He writes that the suspension has not strengthened Ramaphosa any more than it has dealt with corruption. He says that a likely cabinet reshuffle will signal where Ramaphosa believes his ground support will come from in 2022. Read his views here.
- While the ANC was preoccupied with political squabbles, the investment community was eagerly waiting for a review of South Africa’s credit rating from Moody’s Investors Service. Moody’s indicated that reviews on South Africa and a few other countries wouldn’t be coming after all. This is a pity in the sense that stern words from Moody’s could have reminded the ANC leadership what really matters.
- South Africa appears to be on the brink of a third wave of coronavirus infections, driven by a steady increase in new cases after the holidays. New infections climbed 46% in the past week with cases rising fastest in the Northern Cape and Gauteng.
Sources: Dynasty, Bloomberg, The New York Times, The Wall Street Journal, Daily Maverick, BizNews, Business Day, Financial Mail, Moneyweb, etc.