Be alert but not alarmed as market soars


As many of us digested the elevated 12 month returns inked at the end of March, it was somewhat easy to miss the strong returns also witnessed in April. While this is consistent with historical seasonal cycles, the end of April also saw President Biden mark his first 100 days in office with the best US stock market performance under a new president since Franklin D. Roosevelt in 1933.

After taking a pause in March, broad economic data moved higher partly due to the first month of base effects rolling through the year-on-year numbers. The Atlanta Fed’s own GDPNow tracker doubled during April and points to double-digit Q2 US growth (13.6% as at 3 May). On top of these higher expectations, positive data surprises also reaccelerated, with the Citi Global Economic Surprise index now sitting above its 6-month average, indicating that data continues to surprise on the upside. With two-thirds of S&P 500 companies having reported their results, US corporate earnings were unsurprisingly strong with 88% beating EPS estimates (versus 71% last year) and 11% missing estimates (versus 23% a year ago).

In the markets, April was a month of two halves. Strong early gains within equities were followed by sideways trading over the second half of April, predictably around the same time that bond yields started to rise again. This behaviour reinforces just how much financial assets are linked to interest rates. The recent momentum in traded inflation rates provided us with an opportunity to reduce our total duration via Australian inflation-linked bonds.

Hope dawns in the UK, while India’s crisis deepens

Earlier in April we added 2% to our equity allocation via UK FTSE 100 futures. The UK equity market has been flagged by our investment framework for some time, however the clouds of Brexit and the most recent wave of the pandemic were cause for us to hold off. Those headwinds are now abating. Combined with envious vaccination rates, loosening lockdowns and the secondary benefits of European trade reopening, that suggested that the time had come to initiate the trade.

As we moved through the month, markets stalled and signs of fragility increased with breadth falling, especially in high growth US sectors. At the time, other areas of concern were India’s fourth wave of coronavirus and President Biden’s announcement that he would deliver on his campaign promise of raising US taxes. As a result, we reduced our equity allocation by 3% towards the end of the month which now places it near the middle of our 12-month equity allocation range.

India’s pandemic crisis took a turn for the worse with new COVID-19 cases rising above 360,000, the worst daily infection rate of any nation since the pandemic began. While the humanitarian crisis is clear, the political response within India is proving insufficient with no national lockdown and a limited, slowing vaccine rollout. This outbreak has potentially dire global consequences for the world as India is the largest vaccine-producing nation and home to the globe’s biggest vaccine company: Serum Institute of India. It’s estimated that two thirds of the world’s children are inoculated with its vaccines. Supply disruption to this health-critical industry reminds us the war against COVID-19 is far from over and the pandemic requires ongoing close monitoring.

Despite the negative developments in India there was hope in other parts of the world. April saw the global total of vaccine shots administered surpass the 1 billion mark. And, while not a major market event, Bhutan (population 800,000) experienced a meteoric rise in vaccination rates, providing 93% of its adult population with their first injection in just 16 days! In major economies, the UK passed the 50% total vaccination mark, the US added 50% more to its total in the month of April alone, with 43% total vaccinations, and Germany more than doubled its injections to a new total of 27.5%.

Navigating higher highs and lower lows

So where do we stand? Are we on the fence? Have we seen the best of the markets? It’s hard to call today’s setting balanced as it doesn’t correctly reflect the higher highs and lower lows we are experiencing. We certainly subscribe to the view that the easiest returns are behind us and forward-looking returns will be harder to come by. We must also constantly remind ourselves that the only way to know if we have seen the top of the market is to hold on past that point.

To us, this boisterous recovery combined with record highs in most risk assets, both in the US and globally, indicates that too much optimism is being priced into the markets. Our investment framework, underpinned by valuations, supports a level of concern but not alarm as the markets negotiate the dynamics of economic reopening uncertainty. While in the short term valuations alone don’t predict the magnitude of returns, they do point to substantial downside risks should the prevailing tailwinds change.

Today’s elevated valuations combined with near zero interest rates and double-digit fiscal stimulus leaves little room for policy makers or optimistically priced markets to manoeuvre against any negative surprises. Future returns will not be dominated by beta or higher risk taking, but by nimbly adapting asset allocation to avoid the frothiest parts of the market, investing in assets which provide more asymmetric return profiles. This is evidenced by our decision to hedge some of our US high yield position at the end of the month as spreads moved into their richest decile since 1994. Spread levels this tight skew the risk–reward tradeoff against an investor. Thus we prefer to reduce our exposures ahead of any pullback, keeping our powder dry to be deployed in the event of any subsequent spike in volatility.

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