By Rupert Thompson, Chief Investment Officer at Kingswood
Last week saw equities stage another half-hearted attempt at a correction. It got off to a punchy start with markets down 1.5-2% last Monday but that was it. The rebound over subsequent days actually left global equities up 1.2% over the week.
So why the fall? At one level, we were simply overdue one. A decline of 5% or more normally occurs every six months but hasn’t occurred since October. More specifically, markets were unnerved by worries over the spread of the Delta variant.
So, the decline was not really that big of a surprise. Arguably more remarkable was the swiftness of the rebound and there seems to be three factors at work here.
First, while the Delta variant means the global economic recovery won’t be quite as strong as expected, it looks unlikely to derail it. The vaccination roll-out has weakened radically the link between infections and hospitalisations/mortalities. While other countries have been much less gung-ho than the UK in their response to the latest upturn in infections, new restrictions have generally been limited other than in the odd case such as Australia.
Equally as important, economies have become much better at coping with the pandemic. The pingdemic at the moment is causing significant disruptions in particular areas of the UK economy but these problems should ease over the coming month. Indeed, rather surprisingly, infections have declined significantly over the last week.
Business confidence may have weakened in July in both the US and UK but remains at high levels. And in the Eurozone, where the economic rebound has been rather slower, confidence continued to improve. Data out this coming week should show growth in the second quarter running at a strong 8% and 6% annualised pace in the US and Eurozone respectively.
Second, liquidity conditions remain very supportive. Considerable cash is still sitting on the side-lines, looking for a potential home in equities given the poor returns on offer from bonds. Buying of dips looks set to continue. More importantly, central banks still intend to remove the punch bowl from the party only very slowly.
The ECB has fleshed out the implications for its interest rate policy on the back of its recent shift to a symmetric inflation target. Rates now look set to be raised even slower than before, with no increase likely until 2024 at the very earliest. Even in the US and UK, rates should not be raised before 2023.
Third, corporate earnings remain a big support for markets. Reporting for the second quarter is now well underway in the US and once again, earnings are on course to beat forecasts handsomely. The expectation is now for a 78% gain compared with the low point a year earlier, versus 65% at the start of reporting. More meaningfully and just as impressively, US earnings this year should be as much as 20% higher than in 2019, prior to the pandemic.
The cyclical sectors should lead the earnings gains this particular quarter but it is the tech giants that have been the mainstay behind the strong performance over the last two years. Alphabet, Amazon, Apple, Facebook and Microsoft all report over the coming days and their pronouncements will be a major focus.
The tech sector has led the market gains over the last month, benefiting from the rotation back towards growth stocks. However, valuations are now looking on the high side again and we expect cheaper value stocks to come back into favour later this year, as bond yields head higher once again. While this suggests that tech may lag behind the market over coming months, we still believe the sector is relatively well-placed longer term.
Regulatory headwinds have undoubtedly increased in the US. However, unlike in China where there has been a marked crackdown recently, this will be a drawn-out affair. This week’s earnings are likely to confirm the long-term tech growth story remains intact even in the face of any future action by the authorities.