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Going up sideways

May’s returns numbers are in, and the headlines are as follows: a rotation from tech to financials – and from value to growth – as well as a bit more downward pressure on bonds. We have included our usual ‘in review’ table and monthly comments below. Overall, it was a quiet month.

After the sharp rise in economic growth expectations during the first four months of the year, economists in the US have grown used to a more measured pace of policy announcements, especially now that the Biden administration has passed its crucial ‘first 100 days’ yardstick. President Biden proposed a $6 trillion spend budget for 2022, which would have been unthinkable a few years ago. However, US politics has also reverted to its normal pattern when a Democrat is in the White House, with the Republicans just saying
“no”.

 

Conversation returns to fiscal deficits

The pandemic has been hard on everyone’s budgets, and governments are no exception. Over the last year, we have seen politicians all over the world wrack up massive bills for their emergency fiscal support. Most of this has been funded by debt, pushing debt-to-GDP ratios significantly higher in most developed nations. Understandably, this has provoked fear over debt, how it will be paid off or will it spiral; can central banks continue to buy; and what it means for government budgets further down the line?

On the other hand, economists and capital markets seem unphased by this supposedly looming danger. This is surprising, given we have had more than a decade of ‘balanced budget’ rhetoric from politicians, especially on the European side.

 

A picture emerges of rotation and momentum

There is plenty to be positive about in capital markets these days. With the world opening up and the global economy finding its feet again, equities are inching higher on gently improving earnings expectations. These are supported by stable – and historically low – interest rates and bond yields. As we have writte before, in this scenario you would expect bond yields to gradually climb higher with economic growth,
thereby making stocks less attractive by comparison. Central bank action has been decisive in stemming that flow, to the benefit of equity investors.

Nevertheless, stocks have clearly become ‘cheaper’ to some extent. Part of that is down to the fact that bond yields have not been totally immune to the rising tide of global growth, but part of it is just how valuations are calculated. Share prices climb when people expect higher earnings, so if earnings are improving in line with expectations, prices should be stable. And if earnings improve more than equity prices rise, then valuations – in terms of the price-to-earnings ratio – are clearly coming down.

 

Read the full commentary here

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