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Analysis by Damien Petit, Head of Private Banking Investment at Banque de Luxembourg, published in Luxembourg’s economic and financial magazine Paperjam.
Equity markets have posted solid gains since the start of the year despite a marked rise in inflation expectations. Damien Petit, Head of Private Banking Investment at Banque de Luxembourg
Bond yields, which are still very low in absolute terms, have been climbing in recent months. In the US, the engine of global economic growth, 10-year Treasury yields have risen by around 0.7% since the start of the year. Over the last 12 months, they have gained almost 1%. This rise in yields can be attributed to a significant increase in inflation expectations. The 10-year bond market is now expecting average annual inflation of around 2.5% in the US (compared to 1.1% 12 months ago). On the consumer front, the latest University of Michigan confidence survey suggested a slight uptick in long-term inflation expectations. However, it is too early to suggest a substantial change in consumer perceptions of price developments.
A transitory rise in inflation?
The ongoing recovery is being driven by massive stimulus packages and improved mobility thanks to the sustained pace of vaccination in developed countries. Coupled with base effects, particularly in commodity prices, this dynamic is driving prices significantly higher. In April, the US consumer price index rose by more than 4% on an annual basis, which is well above expectations and the highest increase since 2008. Upcoming Federal Reserve meetings could see the start of discussions on a possible reduction in monetary support. However, any reduction remains highly dependent on the evolution of economic statistics, in particular the labour market. The US Federal Reserve considers the current rise in inflation to be a temporary phenomenon. Its continued ‘accommodative’ stance is beneficial to risky assets as investors expect monetary policy to remain highly expansionary.
Equity markets continue to rally, but wide disparity between regions and sectors
Since the start of the year, the global equity markets have posted solid performance (+10% in euros). However, this performance conceals a very wide disparity in terms of sectors (with the more cyclical sectors outperforming) and geography (with emerging markets and Japan underperforming). Meanwhile, it is interesting to note that some market segments are experiencing a significant correction. Profit-taking is salutary and hardly surprising given the speculative craze over recent months. For example, the themed ETF, ARK Innovation, which focuses on companies active in ‘disruptive technologies’, has shed more than 30% since its high in February. The IPOX SPAC index, which reflects the performance of a universe of US-listed SPACs (Special Purpose Acquisition Vehicles), is more than 20% off its peak at the beginning of the year. Crypto-currencies are also suffering, with bitcoin down almost 40% from its mid-April high.
Prospects for equities still attractive
Among traditional asset classes, equities continue to offer the most attractive prospects for returns, particularly in a potentially more inflationary environment. A significant acceleration in global growth – underlined by the upward trajectory of leading indicators – should boost company earnings in the coming quarters. However, high valuations argue for a cautious active management approach and also suggest that absolute returns over the next 10 years will be more limited than in the previous decade.
Link to the full article (in French) in Paperjam
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