Global equity markets put in a robust performance last week, gaining 2.0% in local currency terms with the US leading the way. Despite June normally being the weakest month of the year, equities have resumed their upward course after a pause in May.
Month-to-date, global equities are up 2.1% in local currency terms and a larger 3.7% in sterling terms, on the back of a fall in the pound against a stronger dollar. The continuing gains can really be put down to two factors – liquidity and earnings.
Liquidity conditions remain very supportive. Following the hoo-ha over the recent Fed move to start forecasting two rate hikes in 2023 rather than none, Fed officials last week were at pains to point out that this did not herald a major policy shift. Indeed, QE tapering remains on course to start early next year and the Fed still very much believes the bulk of the surge in inflation is temporary.
Friday’s numbers showed the Fed’s preferred measure of core US inflation picking up further in May to 3.4%. But this rise falls well short of headline consumer price inflation which is now running at 5%. The rise in core inflation has also been concentrated just in a few areas, such as used cars which are subject to particular distortions/shortages. Strip out these outliers and core inflation is running at only 1.7%.
All the same, inflation worries look set to continue over the coming months, with oil prices doing nothing to ease such concerns. The Brent oil price has increased 10% over the month to $76/barrel, the highest level since 2018. This is on the back of expectations of a rebound in demand as economies reopen. Fears of an early return of Iranian exports have also faded with talks between the US and Iran on reviving the nuclear deal going nowhere fast – particularly with a hardliner now elected as the new Iranian President.
Not only does central bank policy remain supportive for equities but a lot of investor cash is also still sitting in money market accounts. This could yet end up in equities given the poor outlook for bonds. Finally, companies will continue to buy back equity. US banks were given the green light on this front last week by the Fed, having passed its stress tests with flying colours.
On the earnings front, the key point is that the market’s gains over the last year have merely kept pace with earnings. Global equity prices are up 40% since last June but so too are forward-looking estimates for earnings. Valuations have in fact declined a little over this period.
The second quarter US reporting season starts in a couple of weeks and looks set to be another blow-out quarter. Expectations are for a 65% gain on a year earlier on the back of the strong global economic rebound. Indeed, last week’s purchasing manager indices showed business confidence remaining buoyant in June, with optimism in the eurozone moving up close to the highs of the US and UK.
Confidence in the outlook for US growth has also been given a boost by news that a provisional bi-partisan agreement has been reached on a $580bn infrastructure spending package. This is considerably smaller than President Biden had been pushing for but the Democrats will now attempt to push through an additional infrastructure bill on their own.
The pace of earnings growth will slow markedly later in the year and the liquidity tap will also gradually be turned off by the central banks. But for now, these twin supports validate the market’s recent gains and leave it still with some further upside – even if this is not that great and is likely to be accompanied by increased volatility.
Here in the UK, the Bank of England meeting was as uneventful as expected but was rather overtaken by affairs elsewhere – pun intended. The MPC kept both rates and the QE programme unchanged. Still, the UK plans to have ended its QE purchases by year-end and will be ahead of the game on this front. The Fed will only just be starting to scale back its bond purchases while the ECB will still be in full-on buying mode.
Rupert Thompson
Chief Investment Officer