Global Macro: Although global macro economic data continued to be positive in July, market sentiment has been dampened by China’s regulatory tightening in the tech and education sectors as well as a potential new wave of Covid infections around the world. Nonetheless, as vaccines seem to be efficient against new Covid variants, the risk of new lockdown measures is reduced. Meanwhile, central banks have maintained their accommodative stance. Although inflation increased in July (5.4% in the US), the Fed reiterated that the rise in inflation was temporary and thus interest rate hikes and bond purchase reduction would not be considered for the time being. As a result, yield curves in the US, western Europe, and China flattened with 10-year rates contracting in July, closer to 1% in the US and negative in Europe. Looking at GDP growth numbers, we note the US estimated Q2 GDP QoQ growth of 6.5% annualized fell short of consensus expectations (8.5%). In China, GDP expansion is on track to reach 8.5% this year, underpinned by pro-growth government policies and new accommodative monetary measures from the PBoC. In the Eurozone, GDP grew 2% QoQ in Q2, above market expectations of 1.5%.
Corporate earnings beat expectations in Europe and the US in July, which supported their respective equity markets. By contrast, Chinese stocks dropped 14% due to tightened regulation on the tech and private education sectors. However, immediate communication from the Chinese regulator, reassuring global investors that China’s massive tech sector development plan was still on track, allowed the Chinese equity market to rebound towards the end of the month. The overall global macro environment remains positive for risky assets in general and equity markets in particular as the three pillars underpinning financial markets are still there: the progressive reopening of the world economy country by country, the fact that inflation is transitory, and central banks’ accommodative monetary policy.
Equity: Month to date the S&P 500 gained 2.6% amid strong corporate earnings whereas the Hang Seng Index plunged nearly 10% following China’s tightened regulation on the tech and education sectors; Euro Stoxx 50 +0.4%. Fixed Income:The 10-year US yield further contracted 24bps in July to 1.24%, which contributed to the rise in High-yield corporate bonds in USD (+0.3%; vs +0.4% in EUR). Emerging Market government bonds edged up 0.1% in USD but fell 2.9% in local currencies. Currencies:The US dollar ended the month flattish with respect to both EUR and CNY while appreciating 1.4% against AUD; safe-haven JPY and CHF were up 1.0% and 1.9%, respectively, against the greenback due to growing concerns over the spread of new Covid variants. Commodities: Oil prices inched up 0.2% in July while gold rebounded 3.0% amid higher-than-expected US inflation.
Covid-19:New waves of infections caused by stronger Covid variants could result in new restrictions and lockdown measures around the world, with a strong negative impact on the economic growth outlook, although higher vaccination rates would limit the risk.
China’s regulatory tightening: Following the implementation of stricter regulations in both the tech and education sectors, Chinese regulators may target other industries, which would further impact financial markets.
Rising long-term interest rates: We expect central banks to start reducing cash injections and tapering their bond purchasing programs within the next 12 to 18 months, which will result in higher interest rates and downward pressure on equity valuations. Meanwhile, investors are requiring higher yields to compensate for the risk of governments’ ballooning debt.
US tech bubble & high US equity valuations:Tech stocks remain under pressure, given the highest valuations since the dot-com era and high market concentration, while the Biden administration is expected to take a much stronger stance on the tax and anti-trust treatment of tech companies.
US-China tensions: US-China trade frictions remain strong, with increasing tension around Taiwan and the South China Sea. In addition, the US is maintaining pressure on Chinese companies listed on US stock exchanges by implementing stricter rules targeting Chinese firms.
Chinese equities: Following the broad sell-off of the Chinese equity market driven by the tech and education sectors, the valuation differential between the Chinese stock market and Western markets has become even more compelling, especially for non-tech sectors that are hardly sensitive to Chinese regulation tightening. According to a UBS study, more than 50% of global investors plan to increase allocations to China over the next 12 months. We note H-share valuations are 30% below their 2018 highs and 50% below their pre-2008 crisis level.
Oil & Gas:The energy sector is a major beneficiary of the global recovery, while long-term anticipated oil demand remains robust. Moreover, we expect energy companies to resume share buybacks and dividend payments, which would be a catalyst for their share price.
Financials: We believe the financial sector will benefit from higher yields and a steeper yield curve when long-term interest rates eventually rise, but also from stronger growth via a reduction in nonperforming loans and the positive impact from lower loan provisions on earnings revisions. This would be positive for both the banking and the insurance sectors, where valuations continue to look attractive. We think stocks of well-capitalized quality banks in the US, Europe, Hong Kong, and Japan will pay above-market dividend yields following their central bank’s green light.
Chinese Yuan: The RMB reflects the forward growth of the Chinese economy and the increase in global trade and investments in RMB. The yuan is also becoming an important reserve currency for central banks and financial institutions, underpinned by China’s strong economic fundamentals: a large positive commercial balance, growing domestic consumption, and interest rates at 3% vs close to 0% in Western economies. Moreover, China became the number one country in the world for Foreign Direct Investments in 2020 according to the UN, with growing inflows from investors buying Chinese stocks, bonds, and hard assets contributing to the strengthening of the renminbi and consolidating its role as a major trade currency.
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