One surprise can conceal another

Chief Investment Officer's team

13 June 2021

Inflation was stronger than expected in May, but the real surprise was to see interest rates falling

AT A GLANCE

Inflation was stronger than expected in May, but the real surprise was to see interest rates falling
The current market narrative is all about continued accommodative central bank policy
We nevertheless decided some adjustments to our Tactical Asset Allocation

Back in January, when we titled our yearly investment outlook “Investing in the Age of Magic Money”, we knew that we had extraordinary times ahead. Still, we keep on being surprised. The headline US Consumer Price Index released Thursday showed a +5% year-onyear increase. There were obviously base effects, from airlines or car rentals, but the gain was higher than what the consensus had expected, including on a month. It is not just base effects. Signs of pressure abund, from the Brent crude closing at its highest level in two years (not one) to China producer prices rising 9% over 12 months. The real surprise however was the market reaction: the US 10-year treasury yield fell 10 basis points last week, and the same happened in Europe.

No doubt, magic money is at play: market participants’ only focus is the Fed’s monetary policy. Most of the inflation came from the reopening sectors, in line with the central bank’s narrative of a short-lived phenomenon which doesn’t require any action. The ECB on Thursday unanimously decided not to change anything, while the G-7 leaders all seem to agree that massive public spending is the way forward.

Markets liked it, and it was another positive week. We had many debates in our tactical asset allocation meeting. Yes, backdrop is a dream, but upside potential is shrinking and animal spirits are red hot. We decided to rebalance some of our active positions, mostly reducing our considerable overweight on stocks, to increase our positions in hedge funds. Don’t get us wrong: we remain overweight equity and underweight fixed income. We are constructive for H2 but simply less outright bullish as we were in H1, and cannot exclude volatility episodes looking forward – they may even be opportunities to add to risk again. Stay safe.

Cross-asset Update

Much ado about nothing. Despite one more strong inflation reading, US long-dated yields continue to remain stuck in a range, with markets celebrating an incredible goldilocks moment. Growth is as strong as it used to be in the good old days, liquidity is more plentiful than ever and investors are convinced that inflationary pressures will be temporary, giving credit to the Fed’s claims in this sense. Many rounds of Quantitative Easing have brought the point home that monetary conditions are the most relevant market driver and one would be bothered about liquidity reaching dangerously low levels only sometime in H2 2022, when central bank balance sheets are expected to stop growing on net. What about the more immediate future? Most likely the forthcoming Fed’s discussion about tapering will be enough to drive volatility, but not to upend the ongoing rally. As for the puzzle of falling yields in the face of a run up in the prices of goods, we would remark that supply shortages in full swing and households flush with savings should see inflation subside substantially only in 2022, leaving room for yields to rise eventually. Actually, past occurrences of an annualised 3-month rise in inflation in the high-single digits, which in short is what we have witnessed up to the May US CPI, saw on average yields drop rather than rise in the subsequent three months. This counterintuitive pattern could simply mean that the first-round effect of inflationary bursts is usually negative on consumer psychology, which then adjusts, so that eventually what matters is whether growth remains strong - it should this year. Bottom line: equities will keep on going up on plentiful liquidity, but watch out for tapering-induced volatility and still refrain from going long duration in spite of the lure of falling yields.

A possible pattern about a staggered recovery is starting to emerge. In simple language, China first exited the crisis and Chinese growth peaked early this year, the United States took the baton and US growth should peak in the current quarter, Europe is now catching up and its expansion rate is expected to top out in Q3. What could come next? Our best guess is that the emerging countries should benefit. In particular, it would be the EM complex ex China, as the latter is still committed to prioritising sustainability versus the shorter-term cycle. The global environment remains supportive, with above-trend growth and abundant liquidity, and the EM-ex-China GDP should swing from negative this quarter to mid-single-digit positive in the second half of 2021 according to some forecasts. Investors seem to be supporting a kind of similar narrative, as EM capital flows have remained healthy. EM equities also have a strong correlation to European stocks, currently outperforming, both falling under the value style category. We are not losing hope on the emerging countries, with EM bonds currently preferred versus DM high-yielding corporate debt and EM equities expected to stage a comeback later this year.

Fixed Income Update

Yields have done it again. This quarter, the 10-year treasury yield has come down by 30 bps from its peak despite strong inflation and low initial claims print. Various explanations are being offered, including shortcovering by institutions and loss of purchasing power due to the higher inflation leading to constrained economic growth. It also seems like the market is finally coming around to trust The Fed’s transitory inflation viewpoint. No doubt, there would be volatility leading up to the next FOMC meeting. However, we believe further rally from here would require dire economic data and a negative assessment of the ongoing recovery, which we think highly unlikely. Hence, our view is that the trend of yields would remain upwards. This could be a good time for clients who are stuck with long-duration bonds to redeem their positions. Both the spreads and the yields are at this quarter’s lows for Emerging Market Sovereign long-duration bonds. We expect this low to be temporary before yields start moving up again.

Spreads remained well-behaved across sub-asset classes. The yield volatility so far has had no effects on the spreads, and different sectors continued to derive the benefit of the lower yields. Last week marked the beginning of the unwinding of the Federal Reserve’s Secondary Market Corporate Credit Facility’s ETF holdings (SMCCF). So far, there has been no visible impact on the market’s functioning. Thus, we expect the spreads to be well-behaved in the near term without any catalyst. However, we would do well to remember that spreads are mean-reverting, and at some point, we would see the reversal happening. Hence, selectivity remains critical in the spread products, including exposure to High Yield and Emerging Market Debt. There were 26 global corporate issuer defaults in the first quarter of 2021, the lowest quarterly defaults since the third quarter of 2019. According to S&P, default activity from the recession in 2020 has likely peaked, and the global trailing-12-month speculative-grade corporate default rate should fall in second-quarter 2021 to 4.8% from 5.4% as of March 2021. YTD total defaults stand at 45.

GCC Market saw a flurry of primary issuance last week with a mix of regular and rare issuers from the region. Saudi Aramco created a new record by selling the largest Sukuk tranche of $6 Bn in its first foray into this asset class. The three-tranche Sukuk is priced within the conventional curve according to investor expectations. Oman issued the first sovereign Sukuk of the region this year, plugging a gap in its debt maturity profile by issuing a 9-year Sukuk with 2030 maturity. Emirates Development Bank, the only Federal entity from the region to issue dollar bonds, tapped the markets for senior 5-year note. Al Ahli Bank of Kuwait issued a PNC 5.5 AT1 USD Sukuk priced at 3.875%. The pipeline continues to be firm, with DAE Funding announcing investor calls. In addition, there are expectations of KFH, Turkey, and Emaar to issue Sukuk in the coming weeks.

Equity Update

We saw a continuing pattern for stocks: global markets stay on a gradual upward trajectory, with gains of half a percent last week, no sharp drawdowns, taking ytd gains to 12%. Markets decided to ignore rising inflation pressures and enjoy the return of demand, especially in the mobility sector with OPEC forecasting strong oil demand growth, accelerated by the global economic recovery. This is reflected in energy which continues to lead global sector returns, as well the UAE and KSA markets which added to already strong ytd gains. Financials took a bit of a back seat last week, with technology stocks gaining as Treasury yields fell. Healthcare was the best performing sector with genomics and biotech stocks trading up, following Biogen announcing an Alzheimer’s therapy. The high R&D spend in the healthcare sector is reflected in the continuing announcement of new discoveries whether it be vaccines or health tec innovation. The S&P 500 made a new high despite higher than expected U.S. consumer price inflation. European equities higher, with most sectors positive and supported by an unchanged monetary policy stance from the ECB which promised to continue to accelerate its bond-buying activity to solidify the economic recovery.

Post our monthly strategic review we retain our overweight on equities with record earnings growth offsetting the higher valuations and support on consumer spend from strong fiscal stimulus and benign monetary policy, with a low rate regime. Our slightly higher overweight positioning for DM continues, as the economies here have led the vaccination drive and economic growth is currently leading EM countries. Our bias however has shifted from the US where we now have a neutral stance and focus more on alpha generation through selection, to an Overweight positioning on Europe which has a relatively stronger eco and corporate profit outlook, following the US’ path on recovery. On EM equities we are overweight but reduce our Asian bias to go neutral EMEA in line with Europe’s recovery. Our strong UAE conviction is retained with many economic, tourism and housing data points supportive of corporate profits accelerating and the attractive continuing low valuations.

2021 has seen the threat of inflation halting the dizzy gains markets had grown to expect from tech stocks, which had led the post-pandemic market rebound. And yet, in spite of rising inflation, an about turn in rising 10- year yields which are the discounting factor for long term future cash flows led to a tech/ FAAMG rally last week, The Nasdaq rose 1.8%, catching up with the S&P 500. Shares in U.S. technology giants did not react to a deal agreed by the G7 for a minimum global corporate tax rate of 15% as the focus now shifts to the G20 countries for a wider agreement. The tax deal won’t affect tech companies unless it's agreed with countries such as Ireland, where many have large bases.

On the value/ growth debate we advocate buying growth/ quality at reasonable valuations. Stay broadly diversified and follow the demand cycle. For the short term focus on recovery sectors but for the medium term keep cognizant of future global trends be it a focus on health and wearables or ESG concerns. EV and 5G are still nascent in adoption and plenty of room for further

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