Equities to outperform in H2 as recoveries dispel tightening fears
Editor’s Note: Jimmy Zhu is Chief Strategist at Fullerton Research. The article reflects the opinion of the author, and not necessarily that of CGTN.
More stable economic data and improving fundamentals in the world’s largest economies could continue to provide key supports to the global stock market, even with the MSCI Global Equity Index already up around 12% in the first half of the year. .
More importantly, there are many signs in financial markets that investors are less concerned about a more hawkish Fed and other central banks.
Most of the massive sell-offs in the stock market in the first half of the year were driven by fears of a faster-than-expected tightening by the US Federal Reserve. But investors now seem more comfortable with a more mildly hawkish Fed.
The VIX Index, one of Wall Street’s famous fear gauges, now drops below the key 20 level and is trading near the lowest levels in almost 18 months.
By measuring the trend of key US economic data over the past six months, the Fed should be prepared to brief the market on part of this quantitative easing (QE) plan over the next six months.
The US unemployment rate fell to 5.8%, the lowest since late 2014. Note that when the unemployment rate fell to this level in September 2014, the Fed began to reduce its balance sheet in three months.
If history is any reliable guide, it makes sense for investors to prepare for the Fed to announce some of the details of the QE cut at the next FOMC meeting in September, or to reveal some of the plans at the meeting. from Jackson Hole in August.
Other leading economic data also suggests that the Fed is ready to withdraw its stimulus package that was carried out last year. ISM manufacturing PMIs over the past six months have hovered around the highest levels in nearly 40 years, and its service PMI just hit the record high in May.
Going forward, the activities of the global economy are expected to continue to recover amid a growing percentage of the global population vaccinated.
However, some existing economic data also suggests that the pace of Fed tightening will be very gradual for this round, as confidence in Main Street lags.
The latest index of the current economic situation from the University of Michigan has fallen sharply this year and the current level is well below pre-pandemic levels of 2019. On the other hand, retail sales in the United States have decreased over the past few months over a month. -on a monthly basis.
Benefits of clamping now
The main reasons for the slowdown in retail consumption and consumer confidence in the economy are soaring inflation and the uneven recovery in the United States.
The Fed certainly has tools to address these issues. Since the Fed began pumping trillions of dollars into the financial system, this has benefited equity investors far more than corporations, as the S&P 500 has risen about 65% since the March low. last year.
If the Fed continues to maintain the current ultra-accommodative monetary policies, this only widens the gap between the rich and the poor.
In addition, many younger generations are now choosing to be day traders rather than work, as the stock markets offer much better returns than collecting wages.
This would have a substantial impact on the economy in the short and long term, as the labor market would tighten further due to the labor shortage, and these young people would also start to lose their skills if they stay too long. long inactive.
On the other hand, the Fed’s decision may also have an indirect impact on commodity prices. Over the past 12 months, the negative correlation between the Dollar Index and the Bloomberg Commodity Index stood at 0.71%.
That said, any message from the Fed to tighten up to potentially appreciate the dollar could push commodity prices down, ultimately easing the current inflationary pressure, which is largely due to soaring commodity prices. .
Surprisingly, the yield on US 10-year government bonds, a key benchmark for the cost of borrowing, did not rise after the Fed surprisingly delivered more hawkish messages at the June FOMC meeting. .
These âweirdâ moves actually revealed some of the key ideas of bond traders – they believe the Fed will be able to manage and contain inflation.
Chinese fundamentals remain strong
China is in a more comfortable position regarding its position to manage inflation, while its economic data shows stable prospects for recovery.
In the second half of the year, a more solid external environment should continue to support the national economy.
The country’s manufacturing PMI has consistently held above 50 this year, and we expect these trends to persist throughout the year and the recovery to be broader.
New export orders have declined this year as some of its major trading partners’ restrictive measures to contain the spread of the virus weighed on Chinese overseas shipping activities.
On the other hand, the stronger yuan has also hurt the earnings of some exporters.
These two challenges should ease in the second half of the year. The cumulative total number of COVID-19 vaccine doses administered has been sped up since May, signaling that more international business activity is expected in the coming months.
In addition, the Fed’s hawkish tone is seen as a positive catalyst for the dollar, which would help ease some of the pressure on the yuan’s appreciation. Data shows that the value of the yuan against the dollar has a negative correlation of 0.85% with the dollar index.
Consumption in China also continues to recover, although recent retail sales figures have fallen below some analysts’ forecasts. But still, retail sales of goods accelerated on a two-year basis in May from the April reading.
We predict that consumption will remain an important factor in driving the country’s growth in the years to come, but it could take some time to reach pre-pandemic levels.
Even with the picture of the recovery underway, we see that the PBOC has little incentive to tighten policies at this time, as the inflationary pressures that are occurring in many other major economies have not emerged in China.
Producer prices may continue to rise in a context of rising commodity prices, but their transmission to consumer prices is still very limited. The national PPI rose to 9% from a year ago, while the growth of the CPI remained at 1.3% over the same period, thanks to stable food prices.
The gap between the two has grown steadily during the first half of the year, suggesting that rising commodity prices have little impact on consumer goods and services.
Limited impact of Fed policy
Various indicators show that financial markets have prepared well for the next potential Fed tightening cycle.
The yield on two-year US government bonds, partly reflecting traders’ outlook on Fed policy rates, remains fairly stable with no visible peak, showing traders expect monetary tightening to be very progressive.
Stocks remain close to the all-time high and the volatility index plummets, suggesting fears about Fed tightening have subsided.
Against this backdrop, we expect stocks to remain broadly flat in the second half of the year, although the upside should be broad at this time.
Meanwhile, policy differences between the Fed and other central banks may bring some volatility to the financial market.
However, the negative impact is quite limited compared to four years ago when the Fed raised the key rate, as the dollar is much weaker than four years ago.
A weaker dollar generally means a healthier global stock market due to the greenback’s safe haven status and less capital outflow from non-US economies.