Inflation, infections, inflexion

Chief Investment Officer's team

14 November 2021

Last week was dominated by stand-out inflation reports from the US and China

AT A GLANCE

Last week was dominated by stand-out inflation reports from the US and China
Interest rates and gold rose materially but stock markets remained steady…
… despite rising infections in Europe and a probable inflection in Chinese policy

Last week was all about October inflation numbers and they were spectacular. In the US, the Consumer Price Index printed a +6.2% year-on-year increase, a level not seen since 1990. In China, while the CPI was a very contained +1.5%, the Producer price gauge, i.e. the factory-gate prices, gained +13.5% in a year, another two-decade record. US officials didn’t change their view that the pressure is transitory and doesn’t require immediate action. However, markets clearly questioned it, with interest rates adding more than 10 basis points on average across the curve. The US 10-year Treasury yield ended the week at 1.56%. Stocks were however resilient: up in emerging markets, and only marginally down in developed ones with the US ending flat.

This was not a bad week for our positioning, overweight stocks and underweight bonds, especially as gold, our latest overweight from our November TAA committee, also glittered, sharply up to $1864 an ounce. Our view on inflation remains somewhat aligned with that of central banks: the primary cause is unleashed pent-up demand meeting constrained supply and logistics, and this should normalize over time. Having said that, timing the normalization could be tricky, and in the meantime, demand itself could be affected by rising infections. The trend is actually not good in Europe nor in the US.

Another inflexion is coming, from the East. China’s 19th Communist Party Plenum confirmed last week that President Xi has full support, virtually forever, to implement policies toward a “modern socialist country”, where socialist is probably the most important word. This is an interesting prelude to the virtual meeting with Biden this Monday. With regards to economic data, we will get the important US retail sales numbers on Tuesday. Stay safe.

Cross-asset Update

The October inflation release in the United States saw the CPI reach a three-decade high, and gold break out of a four-month range, reawakening investor animal spirits in what has so far been a flattish year for the yellow metal. The relationship between gold and inflation is not a straightforward one, with the rally in the decade following the dot-com bubble marked by muted price pressures, yet gold’s almost five-fold gains. In the same period the US 10-real Treasury yield, that is the nominal yield minus inflation, collapsed into negative territory from an initial value of almost 4%. So, it is obvious that the link between the yellow metal and inflation is best explained via real rates, a more complex one and harder to grasp for laymen. The price breakout, then, seems to be telling us that investors believe the Fed will be falling behind the curve in containing inflation pressures, allowing inflation to rise faster than yields. Most likely Fed officials will want to avoid the 2017-18 policy mistake, when they raised policy rates only to see inflation eventually go nowhere. And, after all, Jay Powell at the last FOMC meeting was careful to delink the end of the tapering from the start of the tightening, if anything conveying the clear message that policy would not change unless the winding down of asset purchases is over. In the end, this leaves investors with a time window, extending at most until June next year which is the current deadline for the completion of the tapering, when inflation should stay elevated, while longer-dated yields would be capped by the Fed holding back on policy moves. Real rates would continue to be under pressure, boosting gold to new all-time highs.

Indeed, there is room for the CPI to stay firm or grind a bit higher in the next few months, as shelter inflation is calculated based on a theoretical measure lagging real prices, the Owner’s Equivalent Rent, crude demand is deemed to peak only early next year as per EIA projections, and supply-chain constraints are seen persisting in 1H22. On the other hand, visibility on growth is much less assured, with the central bank liquidity impulse fading in 2022 and lots of uncertainty around the strength of the Chinese recovery. Putting this all together, it seems that gold strength could be more front loaded versus our original assumptions, with the potential for further positive surprises if the market starts to price in delayed hikes as an economic slowdown materializes. The longer inflation and growth continue to diverge and the Fed stays put, the better for gold, which stands a good chance of extending its rally beyond new all-time highs. Although the sustainability of such move is in doubt, its likelihood seems to have grown substantially of late.

Investors have recently flocked to cryptocurrencies, deemed to be the new gold with the promise of accelerated gains alongside inflation protection. We think that this views is simplistic, as the inflation-hedging properties of crypto-assets are as limited as those of equities, both cyclical macro assets, and their outsize returns are also predicated on the exceptional liquidity wave triggered by super-loose central bank policies. As much as gold would be negatively affected by shrinking liquidity, we think that digital currencies would be as well, maybe giving perennial digital bulls a new kind of headache.

Fixed Income Update

The plumbing system of the Fixed Income markets has come under pressure for the first time since the post-pandemic times of Q2 2020. The higher than expected inflation numbers released last Thursday threw ripples across the world’s largest bond market, the US Treasuries. The three-year treasuries marked the largest movement in yields with an 18 bps increase last week. Last Wednesday’s 30-year bond auction was very weak, with the new issue pricing at 1.94% versus an expected 1.88% pre-auction level. Bloomberg Barclays US Govt securities liquidity index is at its tightest levels since March 2020. The MOVE index is at its highest point, indicating that the core treasuries market is in a state of flux and still in a price discovery mode. Markets are at odds with the Fed and are pricing in two hikes before the end of the next year. It remains to be seen who blinks first. But the above indicators suggest the volatility will spill over to the credit markets. Our advice to investors is to stay put with a diversified allocation to High Yield and EM Debt along with remaining underweight duration, which will reduce the effect on their daily MTM movements.

Various segments have come under pressure due to the whipsaw of treasuries, and spreads have widened slightly in the majority of the sub-asset classes. The tightest segments in terms of valuation, such as US High Yield, were the worst affected, with spreads widening by eight bps. However, in terms of overall asset class returns, US High Yield only lost -0.36%, while long-duration assets such as developed market IG and EM sovereign lost close to 1% last week. China was the only bright spot in an otherwise gloomy atmosphere. China Local currency IG Debt has returned 7% YTD and is the top performer as RMB remains at the highest level since 2018.

Asia HY had the best week in the last five months, gaining 2.2% despite extreme volatility. The OAS spreads have compressed by 154 bps to close the week at 11.16% after hitting a high of 12.55% last Tuesday. The driving forces behind this are a gradual stream of reported easing in the regulatory policies. Market sentiment took on a more positive tone following the report by the Securities Times that several developers are to apply for quotas to issue bonds in the onshore interbank bond market. Furthermore, Caixin reported that mortgage lending has increased by RMB 101.3bn during October, signaling an easier stance towards mortgage disbursement. However, we expect the regulators to prefer the baby step methods to a big-bang approach which means the volatility of the tail risk pricing will remain high as there are sizeable onshore debt maturities in December and offshore maturities in January.

The GCC bond market saw some much-needed new bond issuance as both the KSA and Bahrain issued Sukuk and bonds. Both issues priced around the existing curve and investor demand was skewed towards the shorter-dated Sukuk, indicating caution towards the longer-dated maturities.

Equity Update

Global equities finished flat last week with the U.S and Europe falling 0.3% and most EM indices, China, India and the UAE with strong gains. US equities had the overhang of inflation concerns following the biggest CPI increase in over 30 years in October. The accompanying backup in rates was another big headwind given concerns on elevated valuations, especially on the more crowded growth names. The latest data increased the focus on the Fed and worries about a policy mistake. At the same time, the bullish narrative remain intact and the pullback has so far been miniscule. The S&P 500 has finished higher for five straight weeks prior to last week, with continuing record highs. Tech returns closely follow the S&P not yet impacted by the potential for rising rates.

As per FactSet 92% of S&P 500 companies have reported Q3 earnings, the 39.1% y/y earnings growth rate is ahead of the 27.5% estimate at the end of Q2 and the third highest since Q2-10. Revenue growth is at 17.5% y/y. However, inflation continues to be the biggest theme. 285 S&P 500 companies used the term "inflation" during their Q3 earnings calls, the most going back to 2010 and above the previous record of 222 from Q2-21. The mitigant remains margins which are still healthy at 12.9%, estimates for Q4 are at 11.8%.

The Dubai Index continues its upward move with the DFM stock up a 100% since Nov 1st with real estate stocks and banking also performing well, with trading volumes surging. Potential listings in the UAE see the recent addition of Salik, added to DEWA among the 10 state-backed companies to be listed as part of plans to boost activity on the local exchange Companies that have recently listed on the Abu Dhabi exchange i.e. Fertiglobe, Adnoc Drilling, Adnoc Distribution and Al Yah Satellite have focused on strong cash flows and sustainable dividends – always the best performing strategy in the GCC markets.

India had record Diwali consumer sales and is living up to EM consumer demand expectations. COVID is also currently under control with the normal functioning of the economy. Indian inflation started an extended pickup in October, driven by fuel and food. The rate sped up to 4.48% from 4.35%. The Indian Sensex has been one of the best performing stock markets this year and recent successful IPOs such as Nykaa reflect the shift to ecommerce.

COP26 succeeded in highlighting a bright future for zero-emission vehicles. Bloomberg’s 2021 EV Outlook ‘BNEF” states the total global fleet of passenger electric and fuel-cell vehicles is now 13 mn of which 8.5 mn are true ZEVs, either battery electric or fuel cell. That's up from just 4.6 mn at the time of COP25 two years ago. BNEF raised its forecast for the global ZEV fleet to 677mn by 2040. While Tesla gave up some gains, with Elon Musk and his brother selling stakes, it has risen 46% ytd. New listings in the EV domain are following Tesla’s rise, with Rivian valued at $114 bn, up 60% in 3 trading days. Rivian Automotive, backed by Amazon and Ford, recently rolled out the first all-electric pickup truck, the R1T. Electric Vehicles has been one of our key themes this year as we saw plenty more potential in battery makers and other technologies around the manufacturers.

Written by:

Anita Gupta Head of Equity Strategy , [email protected]
Giorgio Borelli Head of Asset Allocation , [email protected]
Maurice Gravier Chief Investment Officer , [email protected]
Satyajit Singh Fixed Income Analyst , [email protected]

Disclaimer

This document is prepared by Emirates NBD Bank (P.J.S.C) (“the Bank” or “Emirates NBD”), a public joint stock company incorporated in Dubai, United Arab Emirates (UAE) and licensed to provide various financial services including promotion, financial consultation, securities portfolio management, managing investments of investment funds, etc. Emirates NBD is regulated supervised and controlled by the Central Bank of the UAE (“Central Bank”) and the Securities and Commodities Authority of the UAE (“SCA”), having its head office at Baniyas Road, Deira, PO Box 777, Dubai, United Arab Emirates. This document may be distributed and/or made available by the Bank and its affiliates and subsidiaries, including Emirates NBD Capital KSA CJSC (“ENBD Capital”) (through its website, its branches or through any other modes, whether electronically or otherwise).

Emirates NBD and its affiliates, subsidiaries and group entities, including its shareholders, directors, officers, employees and agents are collectively referred to Emirates NBD Group.

This publication is prepared without regard to the individual financial circumstances and objectives of persons who receive it. Data/information provided in this publication are intended solely for illustrative purposes for the general information or its recipients, irrespective of their customer classification as an Ordinary Investor or Professional Investor under the SCA Regulations.

Any person (hereinafter referred to as “you”, “your”) who has received this document or have access to this document shall acknowledge and agree to the following terms.

Reliance

This publication may include data/information taken from stock exchanges or other third-party sources from around the world, which Emirates NBD reasonably believes to be reliable, fair and not misleading, but which have not been independently verified. The provision of certain data/information in this publication may be subject to the terms and conditions of other agreements to which Emirates NBD is a party. Opinions, estimates and expressions of judgment are those of the writer and are subject to change without notice. Emirates NBD or any member of Emirates NBD Group makes no representation or warranty and accepts no responsibility or liability for the sequence, accuracy, completeness or timeliness of the information or opinions contained in this publication. Nothing contained in this publication shall be construed as an assurance by Emirates NBD that you may rely upon or act on any information or data provided herein, without further independent verification of the same by you.

The contents of this document are prepared as of a particular date and time and will not reflect subsequent changes in the market or changes in any other factors, including those relevant to the determination of whether a particular investment activity is advisable. Emirates NBD does not undertake any obligation to issue any further publications or update the contents of this document. Emirates NBD may also, at its sole discretion, update or change the contents herein without notice. Emirates NBD or any member of Emirates NBD Group does not accept any responsibility whatsoever for any loss or damage caused by any act or omission by you as a result of the information contained in this publication (including by negligence).

References to any financial instrument or investment product in this document are not intended to imply that an actual trading market exists for such instrument or product. Certain investment products mentioned in this document may not be eligible for sale in some jurisdictions, and they may not be suitable for all types of investors. The information and opinions contained in this publication is provided for informational purposes only and have not been prepared with any regard to the objectives, financial situation and particular needs of any specific person, wherever situated. If you wish to rely on or use the information contained in this publication, you should carefully consider whether any investment views and investment products mentioned herein are appropriate in view of your investment experience, objectives, financial resources and relevant circumstances. You should also independently verify and check the accuracy, completeness, reliability and suitability of the information and should obtain independent and specific advice from appropriate professional advisers or experts.

Confidentiality

This publication may be provided to you upon request (and not for distribution to the general public), on a confidential basis for informational purposes only, and is not intended for trading purposes or to be passed on or disclosed to any other person and/or to any jurisdiction that would render the distribution illegal.

Solicitation

None of the content in this publication constitutes a solicitation, offer, recommendation or opinion by Emirates NBD to buy, sell or trade in any security or to avail of any service in any jurisdiction. This document is not intended to serve as authoritative legal, tax, accounting, or investment advice regarding any security or investment, including the profitability or suitability thereof and further does not provide any fiduciary or financial advice. This document should also not be used in substitution for the exercise of the prospective investor’s judgment.

Third Party

This publication is not intended for use by, or distribution to, any person or entity in any jurisdiction or country where such use or distribution would be contrary to law or regulation. It is the responsibility of any person in possession of this publication to investigate and observe all applicable laws and regulations of the relevant jurisdiction. This publication may not be conveyed to or used by a third party without the express consent of Emirates NBD or its affiliates, subsidiaries or group entities distributing this document. You should not use the data in this publication in any way to improve the quality of any data sold or contributed by you to any third party.

Liability

Notwithstanding anything to the contrary set forth herein, Emirates NBD, its suppliers, agents, directors, officers, employees, representatives, successors, assigns, affiliates or subsidiaries shall not, directly or indirectly, be liable, in any way, to you or any other person for any: (a) inaccuracies or errors in or omissions from this publication including, but not limited to, quotes and financial data; or (b) loss or damage arising from the use of this publication, including, but not limited to any investment decision occasioned thereby. Under no circumstances, including but not limited to negligence, shall Emirates NBD, its suppliers, agents, directors, officers, employees, representatives, successors, assigns, affiliates or subsidiaries be liable to you for direct, indirect, incidental, consequential, special, punitive, or exemplary damages even if Emirates NBD has been advised specifically of the possibility of such damages, arising from the use of this publication, including but not limited to, loss of revenue, opportunity, or anticipated profits or lost business.

This publication does not provide individually tailored investment advice and is prepared without regard to the individual financial circumstances and objectives of person who receive it. The appropriateness of an investment activity or strategy will depend on the person’s individual circumstances and objectives and these activities may not be suitable for all persons. In addition, before entering into any transaction, prospective investors should: (i) ensure that they fully understand the potential risks and rewards of that transaction; (ii) determine independently whether that transaction is appropriate given an investor’s investment objectives, experience, financial and operational resources, and other relevant circumstances; (iii) understand that any rates of tax and zakat or any relief in relation thereto, as may be referred to in this publication may be subject to change over time; (iv) consult their advisers on the legal, regulatory, tax, business, investment, financial and accounting implications of the investment; (v) understand the nature of the investment and the related contract (and contractual relationship) including, without limitation, the nature and extent of their exposure to risk; and (vi) understand any regulatory requirements and restrictions applicable to the prospective investor.

Where this publication provides any information about Shariah compliant products, the Bank will not have engaged a Shariah board (or similar body) to determine independently whether or not such products are compliant with Shariah principles. The Bank accepts no liability with respect to the fairness, correctness, accuracy, reasonableness or completeness of any such determination or guidance by any Shariah board that has certified or otherwise approved such products as Shariah compliant. Nothing contained in this publication shall be construed as a recommendation by the Bank to invest in such product. In deciding whether to invest in Shariah compliant products, you should satisfy yourself that investing in such products will not contravene Shariah principles. You should consult your own Shariah advisors as to whether investing in such products is compliant or not with Shariah principles.

Forward Looking

Past performance is not necessarily a guide to future performance and should not be seen as an indication of future performance of any investment activity. The information contained in this publication does not purport to contain all matters relevant to any particular investment or financial instrument and all statements as to future matters are not guaranteed to be accurate. Certain matters in this publication about the future performance of Emirates NBD or members of its group (the Group), including without limitation, future revenues, earnings, strategies, prospects and all other statements that are not purely historical, constitute “forward-looking statements”. Such forward-looking statements are based on current expectations or beliefs, as well as assumptions about future events, made from information currently available. Forward-looking statements often use words such as “anticipate”, “target”, “expect”, “estimate”, “intend”, “plan”, “goal”, “seek”, “believe”, “will”, “may”, “should”, “would”, “could” or other words of similar meaning. Reliance should not be placed on any such statements in making an investment decision, as forward-looking statements, by their nature, are subject to known and unknown risks and uncertainties that could cause actual results, as well as the Group’s plans and objectives, to differ materially from those expressed or implied in the forward-looking statements. Estimates of future performance are based on assumptions that may not be realized.

Risk

Data included in this publication may rely on models that do not reflect or take into account all potentially significant factors such as market risk, liquidity risk, and credit risk. Emirates NBD may use different models, make valuation adjustments, or use different methodologies when determining prices at which Emirates NBD is willing to trade financial instruments and/or when valuing its own inventory positions for its books and records. The use of this publication is at the sole risk of the investor and this publication, and anything contained herein, is provided "as is" and "as available." Emirates NBD makes no warranty of any kind, express or implied, as to this publication, including, but not limited to, merchantability, non-infringement, title, or fitness for a particular purpose or use.

Investment in financial instruments involves risks and returns may vary. The value of investment products mentioned in this document may neither be capital protected nor guaranteed and the value of the investment product and the income derived therefrom can fall as well as rise and an investor may lose the principal amount invested. Investment products are subject to several risks factors, including without limitation, market risk, high volatility, credit and default risk, illiquidity, currency risk and interest rate risk. It should be noted that the value, price or income of securities denominated in a foreign currency may be adversely affected by changes in the currency rates. It may be difficult for the investor to sell or realise the security and to obtain reliable information about its value or the extent of the risks to which it is exposed. Furthermore, the investor will not have the right to cancel a subscription for securities once such subscription has been made. Prospective investors are hereby informed that the applicable regulations in certain jurisdictions may place certain restrictions on secondary market activities with respect to securities.

Before making an investment, investors should consult their advisers on the legal, regulatory, tax, business, investment, financial and accounting implications of the investment. In receiving this publication, the investor acknowledges it is fully aware that there are risks associated with investment activities. Moreover, the responsibility to obtain and carefully read and understand the content of documents relating to any investment activity described in this publication and to seek separate, independent financial advice if required to assess whether a particular investment activity described herein is suitable, lies exclusively with the investor.

Intellectual property

This publication has been developed, compiled, prepared, revised, selected, and arranged by Emirates NBD and others (including certain other information sources) through the application of methods and standards of judgment developed and applied through the expenditure of substantial time, effort, and money and constitutes valuable intellectual property of Emirates NBD and such others. All present and future rights in and to trade secrets, patents, copyrights, trademarks, service marks, know-how, and other proprietary rights of any type under the laws of any governmental authority, domestic or foreign, shall, as between the investor and Emirates NBD, at all times be and remain the sole and exclusive property of Emirates NBD and/or other lawful parties.

Except as specifically permitted in writing, you should not copy or make any use of the content of this publication or any portion thereof or publish, circulate, reproduce, distribute or offer this publication for sale in whole or in part to any other person over any medium including but not limited to over-the-air television or radio broadcast, a computer network or hyperlink framing on the internet or construct a database of any kind. Except as specifically permitted in writing, you shall not use the intellectual property rights connected with this publication, or the names of any individual participant in, or contributor to, the content of this publication, or any variations or derivatives thereof, for any purpose. This publication is intended solely for non-commercial use and benefit, and not for resale or other transfer or disposition to, or use by or for the benefit of, any other person or entity. By accepting this publication, you agree not to use, transfer, distribute, copy, reproduce, publish, display, modify, create, or dispose of any information contained in this publication in any manner that could compete with the business interests of Emirates NBD. Furthermore, you should not use any of the trademarks, trade names, service marks, copyrights, or logos of Emirates NBD or its subsidiaries in any manner which creates the impression that such items belong to or are associated with you, except as otherwise provided with Emirates NBD’s prior written consent. You shall have no ownership rights in and to any of such items.

IMPORTANT INFORMATION ABOUT UNITED KINGDOM

This publication was prepared by Emirates NBD Bank (P.J.S.C) in the United Arab Emirates. It has been issued and approved for distribution to clients by the London branch of Emirates NBD Bank (P.J.S.C) which is authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority (FCA) and the Prudential Regulation Authority in the UK. Some investments and services are not available to clients of the London Branch. Any services provided by Emirates NBD Bank (P.J.S.C) outside the UK will not be regulated by the FCA and you will not receive all the protections afforded to retail customers under the FCA regime, such as the Financial Ombudsman Service and the Financial Services Compensation Scheme. Changes in foreign exchange rates may affect any of the returns or income set out within this publication.

IMPORTANT INFORMATION ABOUT SINGAPORE

This publication was prepared by Emirates NBD Bank (P.J.S.C) in the United Arab Emirates. It has been issued and approved for distribution to clients by the Singapore branch of Emirates NBD Bank (P.J.S.C) which is licensed by the Monetary Authority of Singapore (MAS) and subject to applicable laws (including the Financial Advisers Act (FAA) and the Securities and Futures Act (SFA). Any services provided by Emirates NBD Bank (P.J.S.C) outside Singapore will not be regulated by the MAS or subject to the provisions of the FAA and/or SFA, and you will not receive all the protections afforded to retail customers under the FAA and/or SFA. Changes in foreign exchange rates may affect any of the returns or income set out within this publication. Please contact your Relationship Manager for further details or for clarification of the contents, where appropriate. For contact information, please visit www.emiratesnbd.com.

IMPORTANT INFORMATION ABOUT EMIRATES NBD CAPITAL KSA CJSC

Emirates NBD Capital KSA CJSC (“ENBD Capital”), whose registered office is at P.O. Box 341777, Riyadh 11333, Kingdom of Saudi Arabia, is a Saudi closed joint stock company licensed by the Saudi Arabian Capital Market Authority (“CMA”) under License number 37-07086 dated 29/08/2007G (corresponding to 16/08/1428H) to deliver a full range of quality investment products and related support services to individuals and institutions in the Kingdom of Saudi Arabia. ENBD Capital is subject to Capital Market Law, and Implementing Regulations in the Kingdom of Saudi Arabia

ENBD Capital’s contact details are T +966 (11) 299 3900 and F +966 (11) 299 3955.

This document may not be distributed in the Kingdom of Saudi Arabia except to such persons as are permitted under the Investment Funds Regulations issued by the Capital Market Authority.

The Capital Market Authority does not make any representation as to the accuracy or completeness of this document, and expressly disclaims any liability whatsoever for any loss arising from, or incurred in reliance upon, any part of this document. Prospective subscribers of the securities offered hereby should conduct their own due diligence on the accuracy of the information relating to the securities offered. If you do not understand the contents of this document, you should consult an authorised financial adviser.

more app