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SystematicEdge March 2021 Market Overview

08 April 2021

MARKET CONTEXT: Biden’s New Deal: Stimulus for the World Economy

Global Macro:  US President Biden has announced his US$2.25 trillion infrastructure plan, which comes on top of the recovery package of US$1.9 trillion. In total, stimulus measures announced since 2020 correspond to 25% of the US GDP. The infrastructure plan will be rolled out over the next 8 years with a large portion of the total spending to take place in the coming 3 years. The plan will have a number of consequences. First, as the stimulus package will be financed by US Treasury issues, we expect yields to keep rising, which would worsen the US ballooning debt. Second, the massive US dollar printing and deterioration of the US budget will cause the greenback to depreciate with respect to other currencies, thus contributing to the US dollar’s secular bearish trend. Third, taxes in the US will most likely increase. The Biden administration proposed to raise the corporate tax rate from 21% to 28%, which would have a negative impact on corporate earnings and therefore S&P 500 valuations. In addition, the US will need much more goods and materials than they can produce, so we believe US imports will increase significantly, favoring China in particular but also other trading partners such as the EU. Meanwhile, European countries like France are imposing new lockdown measures amid rising Covid-19 cases, thus delaying the economic recovery. China is leading the post-Covid recovery with economic indicators at higher levels than before the pandemic: industrial and service PMIs (Purchasing Managers’ Indices) have exceeded expectations while profits earned by Chinese industrial firms surged 180% in Q1.

Financial Markets: The equity market performance was driven by regions and sectors that benefited the most from the recovery. As such, cyclical sectors, such as financials and industrials, outperformed technology stocks. Markets with high P/E (price-to-earnings) ratios, such as the S&P 500, started to underperform with an average P/E of 40. This level was last seen in 2000, before the internet bubble burst. This rotation from highly valued stocks was accelerated by the rise in US Treasury yields, with the 10-year yield almost doubling from 0.90% in Q1 to 1.75%. Higher long-term rates weigh on high P/E stocks and benefit lower P/E stocks, such as financials and energy. Although we believe US stocks are expensive overall and at risk of undergoing a correction, short-term market indicators support the ongoing rally, including large inflows in Q1 as well as positive sentiment from both investors and corporations. In China, policymakers have highlighted the importance of reducing leverage in the financial system while new regulation on the financial business of Chinese e-giants has been implemented. However, the reduction of liquidity by the Chinese monetary authorities, in order to reduce leverage, spooked the market.  The tighter liquidity in China resulted in Chinese equities losing more than 2% in March.  Nonetheless, we believe China would benefit from a more stable economy with high-single-digit growth. The US has been rolling out stricter rules on Chinese equities listed in the US, increasing the risk of Chinese stocks being delisted from US exchanges.  Subsequently, Hong Kong is already taking advantage of the listing of Chinese firms that cannot rely on US listings to access foreign capital.

Equity: Month to date the S&P 500 gained 4.3%, Euro Stoxx 50 +7.8% while the Hang Seng Index lost 2.1% on expectations of tighter monetary policy and decreased liquidity in China. Fixed Income: The 10-year US yield further rose 29bps in March to 1.75%. As a result, Emerging Market government bonds declined 0.8% in USD and 2.5% in local currencies. High-yield corporate bonds edged down 0.5% in EUR and up 0.5% in USD. Currencies: The US dollar continued to appreciate with respect to major currencies, underpinned by the rise in long-term interest rates: EUR -3.0%, CNY -1.2%, AUD -1.5%; safe haven JPY -3.9%, CHF -3.9%. Commodities: Oil prices declined in March amid concerns over rising Covid-19 cases worldwide while gold prices further contracted: WTI Oil -3.5%, Gold -1.5%.

Risks: 

Following Biden’s new deal, here is our updated list of risks:

Opportunities: