The equity party that investors have been enjoying will continue in this Olympic summer, at least according to Arnout van Rijn, chief investment officer, Asia Pacific at Robeco.
He says economic recovery remains on track and corporate earnings prospects are promising. He is bullish but is aware this view relies on central bank cooperation.
While global money supply growth has been slowing, it is still abundant and central banks have done their best to convince investors they will not take the proverbial ‘punch bowl’ away from the current easy money party anytime soon.
He also points out that global equities may seem expensive from a multiples perspective (20x expected earnings, 3x book value), but they look attractive when compared to bond market valuations.
As dangerous as these very loose monetary policies may seem; van Rijn insists that, from a longer-term perspective, they make it next to impossible to recommend that clients reduce risk – at this point at least.
With so much money floating around, any market correction will most likely be met with quick buying. He says investors have to stay bullish, even though he’s well aware that this view relies on central bank cooperation.
“Both our developed and emerging markets equites teams have kept a positive stance on their respective stock markets for this quarter and have not made any changes to the five underlying factors of our analysis framework. For now, we believe that the current ‘Goldilocks’ environment – with inflation and economic growth neither too high nor too low – will continue for some time,” he says.
Quantitative easing
He goes on to say that in the US, government and central bank have successfully pulled out all the stops: further extension of quantitative easing, explosive money growth, massive payroll support and even heftier infrastructure spending. As a result, he says, the economy is back on track, jobs are returning, and consumers’ savings will now be spent in the service economy.
In Europe, recent economic news has also been encouraging. “Governments seem to focus less on daily new covid-19 cases, and more on reviving economies and people’s spirits alike, after a rather depressing spring.”
In Japan, domestic demand remains lacklustre, but the economy is supported by its strong export position in a recovering world, van Rijn says.
“In this context, it is remarkable to see the yen lose ground against a rather weak dollar, and we believe there is upside for this risk-off currency. Unfortunately, we can’t use our cheap yen to travel to Japan this summer and watch the Olympics. The Games are on, but spectators will be watching it on a TV-screen.”
He also remains upbeat regarding emerging markets, despite their recent lagging performance, as he believes this is partially due to initially slower vaccination rollouts, and because Chinese markets are no longer contributing after a stellar 2020.
“Now that the Chinese economy has fully recovered and is back to more sustainable growth rates, its equity markets feature a relatively weak earnings outlook for 2021.
That said, the historically high valuation gap – of about 30% – between emerging and developed markets clearly points towards a catchup. “Admittedly, valuation multiples typically are lower in emerging markets than in developed ones, but we believe the gap should narrow over time, especially now that increasingly large swathes of the emerging market universe are technology oriented.”
Tax worries
So, under these circumstances, what could possibly spoil the equity party this summer?
Besides a resurgence of the covid-19 pandemic, one threat for markets may come from the global agreement on the 15% minimum corporate tax rate, van Rijn suggests. “Higher taxes are the inevitable flipside of the government largesse we have seen in the Western world. Taxpayers and those that were on the receiving end last year will eventually be asked to foot the bill. And large corporates certainly have been on the receiving end with record-high profitability. So, higher taxation should eventually lead to lower (after-tax) profitability.”
Inflationary pressure represents the other elephant in the room. Warning signs have proliferated in recent months, with shortages in several critical areas, such as semiconductors, shipping containers and even in crude oil.
“Quite a few of the companies we hold in our portfolios have responded by raising prices. Any new evidence on the direction taken by inflation this quarter will be scrutinised in light of what it may mean for monetary policy.”
Central banking party
From that perspective, all eyes will be on the Fed’s annual ‘central banking party’ in Jackson Hole, towards the end of August.
“Ever since the financial crisis of 2007-2009, markets have become obsessed with every word central bankers utter. So far, major central banks have taken the view that inflation will be transitory and unlikely to cause them to alter their course of action.”
One point van Rijn is keen to point out is that for all the conjecture recently about inflation, fast-rising consumer prices have essentially remained a US phenomenon. Elsewhere, inflation remains much more subdued. In China and the Eurozone, for instance, consumer prices are rising at around 1% and 2%, respectively, and in Japan they remain broadly flat.
One more reason for central banks to hold fire and not rush to tighten their monetary stances is that accommodative financial conditions will be instrumental in funding the transition towards a low-carbon economy. Van Rijn concludes: “In times of climate emergency, with colossal investments needed from both the public and private sector in the coming years, this may prove to be the ultimate argument for central bankers to keep money flowing at the expense of temporarily higher inflation.”
Corné van Zeijl, strategist at Actiam, says that looking into the future; capex from companies will indeed increase. “One reason is the de-globalisation trend. For instance, most regions want to set up their own semi-conductor industry. As the high dependence of this crucial part of business processes is unwanted.”
He adds: “Another reason is the green investment wave will also impact capex. If those factors will lift off the velocity of money, central banks cannot increase the monetary base anymore with current growth rates, without leading to higher inflation rates. So, you can’t have your cake and eat it. Higher capex will have a positive effect on the economy. But this will lead to less stimulus. Which has a negative impact on equities.”
Momentum slowing
Kevin Thozet, member of the investment committee at Carmignac, suggests we are now in a context characterised by a weaker macroeconomic momentum, and along the way lesser earnings growth momentum.
Consequently, he argues that there is an inclination for investors to take lower risks over time as they increasingly acknowledge that we are returning to a more normal growth environment.
“We would tend to be more wary in terms of risk taking. With on the one hand inflation prospects starting to fade along with the prospects of not-so-lenient central bankers; while the negative impact of the Delta variant and the lesser potential of fiscal stimulus in the US are also poor omens for future growth.”
He adds: “Equity markets have/are largely benefiting from the exceptional environment with earnings per share expected to grow at close to 40% this year. But with an environment which should be characterized by lesser exceptional support as we return towards some form of normality, so should earning expectations – which are expected to revert towards long term averages of around 10%.”
In such an environment, Thozet believes ‘visible’ growth stocks should fare particularly well and as such they constitute the backbone of Carmignac investments right now.
