Jul 8, 2021
The tussle between economic optimism and inflation concerns continued to play out in the second quarter (Q2). Financial markets had a strong quarter overall, supported by the ongoing rollout in inoculation programmes, falling COVID cases, and the gradual return to some semblance of normalcy in the developed world as countries lifted lockdown restrictions.
Optimism surrounding the global economic restart and the return of inflation continued to favour value over growth stocks, although growing concern over the Delta variant saw growth stocks rebound in June. Global equities (MSCI All Countries World Index) consolidated gains in June to end the quarter up 7.4%. Developed market equities (MSCI World Index) ended the quarter 7.9% higher, outperforming their emerging market peers (MSCI Emerging Markets Index, +5.1%). Regionally, US equities (S&P 500 Index, +8.5%) enjoyed one of their best first-half performances since 1998, supported by solid Q1 earnings growth, the prospect of additional fiscal stimulus and growth stocks bouncing back in June. European equities (Euro Stoxx 600 Index, +5.5%) continued to benefit from global growth optimism, the acceleration in vaccinations, alongside a dovish European Central Bank (ECB), although COVID-sensitive sectors such as travel and leisure fell on Delta variant concerns. Elsewhere, mainland China’s CSI 300 Index (+5.7%) rode a strong earnings season and foreigners snatching up local stocks on the yuan’s advance, while a slow vaccine rollout in Japan held the Topix (-1.0%) back over the quarter.
Inflation jitters were a source of volatility in bond markets. The Bloomberg Barclays Global Aggregate Bond Index closed the quarter up 1.3%, although returns diverged across regions, with UK and US bonds outperforming European sovereigns. For investment-grade credit, high yield continued to outperform year-to-date. In the cryptocurrency space, it was a brutal quarter on the back of energy consumption critique and a tough regulatory crackdown by Chinese authorities, with Bitcoin plunging 41.3% in Q2.
All returns are quoted in US dollars.
The US economy continued to roar ahead in Q2 in response to fiscal largesse, re-openings and an impressive inoculation programme. The manufacturing and services purchasing managers’ indices (PMIs) rose to record levels during the quarter, reflecting record factory activity amid reopening. CPI inflation soared to a 13-year high of 5% in May from 4.2% in April and above consensus expectations of 4.7%. The US Federal Reserve’s (Fed) preferred inflation measure, the personal consumption expenditures index (which strips out food and energy), rose to 3.4% in May (3.1% in April) taking it way above the Fed’s 2% target, and the highest level since 1992. The Fed view, however, remains one of a temporary push in inflation in 2021 amid the ‘restart’, but which should fade overtime and settle back to the Fed’s 2% target. In line with consensus expectations, the Federal Open Market Committee made no changes to policy at the end of its two-day policy meeting on 16 June. However, what captured most investor attention from the meeting was the publication of the so-called ‘dot plot’ (which notes individual member projections for interest rates) showing seven members (up from four) now seeing the first rate hike coming in 2022 and two hikes in 2023 (previously none). Fed Chair Jerome Powell, however, reiterated that these plots ought to be taken with a “grain of salt” as they represent individual forecasts and not the FOMC view as a collective.
The European Union got off to relatively slow start in rolling out vaccines, but they have since turned that corner, narrowing the gap with the US and at the time of writing, the bloc may well leapfrog the US in first dose inoculations, as the latter grapples with vaccine hesitancy in some states. This impressive turnaround in inoculations across Europe is turning up in the economic data as retailers, restaurants, and bars reopen and summer travel resumes. Economist expectations for robust growth this year have improved, with several high-frequency data pointing to a strong rebound in Q2 from a double-dip recession. Earlier in June, the ECB raised its growth forecast for the currency area to 4.6% this year, although citing concerns of rising financial stability risks developing asset bubbles. The ECB’s Governing Council meeting on 10 June 2021 was relatively dovish as the pace of quantitative easing was stepped up despite the pickup in activity. Inflation slowed in June to 1.9% from a year earlier, down from 2% in May, while core inflation cooled to 0.9%. The dominant view on the council is that the uptick in inflation will be transitory, while elevated unemployment and a weaker medium-term outlook calls for a continuation in current policy, supported by fiscal support from member states.
The UK ‘s economic rebound continued over the second quarter, with the recent GDP print for April coming in at +2.3% on the month, ahead of consensus expectations of 2.2%, marking the quickest pace in growth since July 2020. Business activity in June was robust as the country continued to reopen, with businesses reporting strong consumer demand, especially in the hospitality sector. Although PMI readings in June (composite at 61.7) were slightly off the record pace seen in May (62.9) and below consensus (62.8), these are still the strongest levels of activity in more than a decade. The robust recovery does, however, come with an inflation warning sign, as supply chain bottlenecks and shortages put upward pressure on input costs. The Bank of England (BoE) Monetary Policy committee (MPC) unanimously voted to keep the Bank rate at 0.10%, while outgoing BoE Chief Economist Andy Haldane voted for a reduction in gilt purchases and urged policymakers to tighten policy on inflation concerns. The consensus view on the BoE remains in line with that of the Fed, that price pressures are largely “temporary”. BoE Governor Andrew Bailey’s remarks on the last day of the quarter reinforced this view as he reiterated the MPC’s intent to overlook the temporary spike in inflation to 3% this year as the economy recovers from 16 months of lockdown.
Recent indicators point to a more balanced and stabilising Chinese economy, following record growth in the first quarter of this year. The official manufacturing PMI was broadly stable at 50.9 in June from 51.0 in May, but this was the lowest reading since March. The non-manufacturing gauge on the other hand, came weaker than anticipated at 53.5 in June from 55.2 the previous month as the recent spike in COVID cases in some regions and notably, the major economic province of Guangdong, added further pressure on supply bottlenecks. New orders shrank for the first time in four months as re-openings in Western countries shifts consumption patterns away from China, whose economy benefited from robust global demand for its exports as it was the first economy to restart since the Great Lockdown. The latest PMI readings have reinforced economist expectations that domestic growth will continue at a healthy rate throughout the year, but will gradually ease, and thus provide the People’s Bank of China (PBoC) enough room to maintain its policy stance. The PBoC struck an upbeat tone at its quarterly meeting in late June, reiterating its stance to maintain policy, liquidity and the exchange rate at current levels – quelling fears of an impending tightening in policy, while also indicating a shift in focus more toward the global policy environment so as to counter exogenous shocks.
The South African economy grew by an annualized 4.6% on quarter in Q1 2021, following a downwardly revised 5.8% in the preceding fourth quarter 2020, and comfortably clearing expectations of 2.5% growth. As per StatsSA, eight of the 10 industries recorded positive growth, with finance, mining and trade industries in particular, doing most of the heavy lifting. Electricity shortages and disruptions to water supplies on the other hand, saw those sectors weigh on growth. Sentiment on factory floors waned in June, albeit less than expected, following the tightening of lockdown restrictions on 27 June 2021. The ABSA PMI compiled by the Bureau for Economic Research, dipped lower to 54.7 in June from 57.8 the month prior, overall a positive reading with the gauge averaging 57.2 in Q2 compared to 53.8 in Q1. That said, the intensity of the third COVID wave currently sweeping through the country and the duration of Level 4 restrictions will determine the strength of the recovery into the third quarter. Consumer confidence (especially for the lower income groups) soured in the second quarter as the end of the government’s social welfare payments programme expired.
Headline inflation soared to a 30-month high in May (largely due to base effects), printing 5.2% from a year earlier, relative to 4.4% in the previous month, taking it well above the midpoint of the South African Reserve Bank's (SARB) 3 – 6% target range. The SARB policy committee unanimously left interest rates unchanged at its 21 May meeting. The central bank raised its economic growth forecast for 2021 to 4.2% from 3.8% mainly on the back of a stronger commodity price outlook. The inflation forecast was trimmed to 4.2% in 2021 and unchanged at 4.4% and 4.5% for 2022 and 2023, respectively.
The Bloomberg Commodities Index ended the quarter up a strong 13.3% and 21.1% for the first half of the year. Most commodities have cooled from peak pandemic prices, but some continue to attract bullish attention. The resurgence in fuel demand lifted international oil prices during the quarter (Brent crude price is up 45% year-to-date and West Texas Intermediate +51.4%), as developed nations eased restrictions on travel, while OPEC+ kept the lid on supply and Iran is yet to come back online. Iron ore prices soared to record levels during the quarter amid robust demand for this steel-making ingredient, notwithstanding Chinese authorities stepping up efforts to arrest runaway commodity prices. Gold endured its worst month since November 2016 on a slightly hawkish Fed, but the yellow metal had a good second quarter, nonetheless, especially coming off a weak Q1.
Figure 1: Q2 2021 % change (US$)
Source: Bloomberg as at 30.06.21.
Turning to South Africa, June was the fly in the ointment for the stock market, when the seven-month long winning streak snapped. In context, however, South African equities have delivered their best first-half performance since 2007, with the benchmark FTSE/JSE All Share (ALSI) and Capped SWIX both up 13% year-to-date. For the quarter, the ALSI ended a flat +0.1%, while the Capped SWIX was a slightly better +0.6%. At a super-sector level, financials (+7.9%) led performance, while industrials were up a soft 0.7% and resources down a hefty 5% over the period. Local bonds (JSE All Bond Index, +6.9%) soundly outperformed their equity counterparts as the bond market continued to benefit from a supportive mix of external and domestic dynamics, with the downward trend in yields (yields fall as prices rise) sustained across most tenors over the period. Listed property (JSE All Property Index) posted a strong quarter amid the reopening trade, despite a wobble in May, to finish the quarter up +11.5%. Cash, as measured by the STeFI Composite Index, was broadly unchanged at 0.3% for the quarter. Despite the pullback in June as the greenback enjoyed some time in the sun, the rand still fared stronger against the US dollar, euro and pound sterling over the quarter as a whole.
At the sector level, basic materials relinquished leadership over the second quarter, shedding a lot of the outperformance from Q1 as resources prices cooled down from their pandemic peaks. ‘SA Inc.’ (companies that derive most of their revenue from South Africa) sectors performed relatively well over 2Q, notably general industrial names, banks, retailers, travel & leisure, which stand to benefit from the recovery and encouraging momentum on the reform front.
Selection of FTSE/JSE All Share Index stock performance
|Name||Index weight||Q2 2021 % return (ZAR)|
|Distell Group Holdings||0.2||43.1|
|The Foschini Group||0.6||29.5|
|British American Tobacco||1.8||-1.3|
|Anglo American Platinum||1.2||-23.4|
Source: Bloomberg as at 30.06.21.