Is this bull market in equities just too good to last?
Equity markets started June on a positive note and, so far at least, ignore the fact that June is traditionally the weakest month of the year. Global stocks rose 0.7% in local currency last week and are now about 1% above their peak a month ago.
The good performance was not limited to equities. Government bonds remain calm despite growing fears of overheating economies. Indeed, 10-year US Treasury yields are currently 1.6%, about 0.2% below their high at the end of March. Meanwhile, the extra yield offered by corporate bonds over government bonds fell in the US and UK to hit lows in 2018.
Potential returns from stocks appear higher than those from bonds
Potential returns still seem higher for stocks than for bonds, where the return outlook remains very low. Despite this, we believe stocks are facing rather choppy waters with potential returns that aren’t as high anymore. For starters, the strong rebound in earnings has driven the market’s sizable gains over the past year, but earnings growth will slow again later this year.
Equities will also most likely face further upward pressure on government bond yields. Overheating concerns may well get worse before they get better. US inflation jumped in April and May data released this week should show a further rise. The Fed has been adamant it will monitor this surge, believing it to be temporary, but recently some doubts seem to have settled on this front.
The problem is, the data is currently so skewed by the pandemic and bottlenecks as economies reopen that it’s unclear how transient this pick-up in inflation will be. The uncertainty is only heightened by the unprecedented scale of monetary and fiscal stimulus.
Still, some consolation can be taken from the fact that much of the recent strong rise is concentrated in a few categories. For example, in the United States, used car prices have skyrocketed. One-off factors, such as chip shortages affecting new cars, as well as reluctance to use public transport due to Covid and the big stimulus checks handed out earlier in the year, seem to be mainly to blame.
Labor shortages hit the US and UK
That said, widespread labor shortages now appear to both limit the recovery in employment and trigger wage increases in the US and here in the UK. Again, it will be some time before it becomes clear whether this is temporary or not. It is only when Covid’s support measures end over the next few months that we will begin to see how many beneficiaries will re-enter the workforce, easing these pressures.
Although interest rates still appear unlikely to be raised in the US, UK and Eurozone before 2023 at the earliest, the inflation news will give central bank talks increased urgency on when to start cutting back their quantitative easing programs. The coming months should see central banks laying out their plans and this could be a source of volatility as markets get used to the idea that the days of easy money begin to come to an end.
Recent headlines, however, have all been about the upcoming G7 shindig in Cornwall and, more importantly, their plans to tackle corporate tax evasion. Their project is that a minimum overall corporate tax rate of at least 15% and that 20% of the profits of the largest and most profitable multinationals be taxed according to the location of their sales.
The deal has yet to be ratified by the G20 and the OECD and the devil will be in the details. So, the impact this will have on corporate profits is far from clear. While the movement undoubtedly represents a headwind in the medium term for most international sectors, such as technology, it is indeed an accessory for the markets in relation to developments on the monetary and inflationary fronts.