Since the start of the year equity markets have rallied on optimism of a rebound in global growth. Developed market (DM) equities led by the US have moved significantly higher on the back of the successful vaccine roll out and the expectation that this will allow their economies to re-open, alongside the continued accommodative stance of central banks.
Inflation has been moving higher recently but markets have been guided by the US Federal Reserve to view it as transitory. The current inflation prints are higher partly due to base effects but also due to supply chain shortages. Easing lockdown restrictions have led to a dramatic rise in demand, and the global supply chains still being impacted by COVID-19 have not been able to satisfy this demand. As more economies fully reopen this dynamic will fall away allowing price pressures to dissipate.
Meanwhile Emerging market (EM) equities have lagged since the middle of March partly on concerns that vaccine shortages will slow economic growth. In Asia the rise of infections and repeated lockdowns coupled with China’s recent regulatory moves has dented overall sentiment.
All of this has resulted in significant divergence in equity markets’ performance with a year to date gap of around 30% between the top and bottom performing markets.
That said, it is worth noting that while DMs have outperformed, there are pockets of opportunities in EMs. Korea, for example, with its more open economy and resultant exposure to global growth could outperform its Asian peers as we move into the 4th quarter.
According to the Eastspring Portfolio Advisors team, leading indicators continue to point to sustained global growth well into the second half of 2021 which bodes well for equity markets. Equities still offer attractive relative returns given the low yields on DM bonds, but the broad-based equity gains seen from the lows in March 2020 are likely behind us. A lot of good news has been priced in at this point, so investors need to watch how the US Fed adjusts to the higher growth/higher inflation narrative. Given this backdrop the team expects to see a continuation of the divergence in equity market performance the rest of the year. It is this divergence in performance that offers the opportunities ahead and amplifies the need for tactical asset allocation.
The key risks to this view are delayed re-openings due to COVID-19 variants and earlier than expected withdrawal of policy support by DM central banks.
Source: MSCI Total Return Indices (USD) from Refinitiv Datastream as at 16 Aug 2021