Strong but spotty growth for 2H2021

Covid-19, which is believed to have originated from China in late 2019, had quickly spread to the rest of Asia Pacific in January 2020. By February that year, the coronavirus had entered Europe, North America, South America and other parts of the world. On March 11, 2020, Covid-19 was declared pandemic status by the World Health Organization.

Fearing the worst, investors began dumping shares en masse. In the US, the S&P500, Dow Jones and Nasdaq plunged to multi-year lows. In Asia, the Hang Seng, Nikkei 225, Shanghai Composite Index and Shenzhen Composite Index also plummeted. The Straits Times Index, too, was not spared.

Since then, stock markets around the world have staged a remarkable comeback. It was almost as if the pandemic had never occurred.

China’s equity markets were the quickest to rebound. Within three months, the Shanghai Composite Index and Shenzhen Composite Index had completely recovered lost territory. So far this year, the indices are up 3.4% and 2.9% respectively.

Similarly, Hong Kong’s Hang Seng and Japan’s Nikkei 225 are up 5.6% and 5.2% respectively, year to date. Meanwhile, the S&P500, Dow Jones and Nasdaq, are scaling new highs. All three indices are up 12.3%, 12.5% and 7.9% respectively, year to date.

In Singapore, the STI had regained most of its losses. The benchmark index is up 10.9% so far this year, led by a strong rebound of the index heavyweights DBS Group Holdings, Oversea-Chinese Banking Corp (OCBC) and United Overseas Bank (UOB).

To many market observers, the swift pace of recovery is astonishing. Eli Lee, head of investment strategy at the Bank of Singapore (BoS), says the market peak to trough to peak again during the pandemic took only eight months. This is “phenomenally fast” and “unprecedented”, he exclaims.

“Many market observers and investors tracking the [impact of the] pandemic were absolutely stunned by the pace of the recovery. Those who were looking for a double dip or a more drawn-out recovery were completely shocked,” he said at an outlook briefing on June 6.

Lee believes the global market is now experiencing an “accelerated cycle” unseen before because the global market is overflooded with liquidity. As a result, the speed and magnitude of market movements tend to be exaggerated, he explains.

Last year, the US Federal Reserve had launched a suite of emergency lending schemes and increased its monthly asset purchases. This has now almost doubled the Fed’s balance sheet to just under US$8 trillion ($10.6 trillion) as at June 1 from US$4.1 trillion at the start of 2020.

The European Central Bank (ECB) too had embarked on an aggressive asset purchase programme. Late last year, the central bank expanded its monetary stimulus by another EUR500 billion ($805.5 billion). As at June 4, the ECB’s balance sheet totalled EUR7.7 trillion from about EUR4.7 trillion in March 2020.

Interest rates are also at their lowest historically. The US Fed funds rate is at between 0.00% and 0.25% while the Bank of England’s base rate is at 0.1%. Others like the ECB’s deposit facility rate and the Bank of Japan’s overnight rate are negative.

Now, despite soaring equity markets, there are still risks ahead. For one, the Covid-19 pandemic has yet to be eliminated. Subsequent waves of the coronavirus, including several mutated variants, continue to wreak havoc across the world including many parts of Asia.

Countries that previously had Covid-19 under control, including Singapore, have re-implemented strict measures to contain new outbreaks. These inevitably will have economic and financial repercussions.

Secondly, higher than anticipated inflation could destabilise the US economy and, by extension, the global economy and financial markets. Although the Fed has downplayed inflation as “transitory”, market observers are not entirely convinced.

Mansoor Mohi-uddin, chief economist at BoS, says the Fed is willing to allow inflation to creep above its target of 2% for a period. This is so that the central bank can achieve an average 2% inflation rate over the business cycle, he says.

“[But] some investors and economists are concerned that [with] the Fed allowing inflation to take hold [above] 2%, [it may] then require much tighter monetary policy to bring inflation back under control. And that would obviously be bad for risk assets,” Mohi-uddin said at the same BoS briefing.

So how will economies and financial markets perform ahead?

Uneven recovery

The good news is that most economies are expected to see a strong recovery in 2021. This is largely driven by a low base as many economies recorded negative growth last year. But the recovery will be uneven across economies.

Selena Ling, chief economist at OCBC Bank, says there are some obvious leaders. “The US, for instance, will see a much stronger recovery compared to last year … But you can see that some other economies are still struggling with the Covid-19 resurgence,” she said at an outlook briefing on June 7.

The distinguishing factor, says Ling, is the pace of vaccination. Certain countries, like the US, UK and Israel, are far ahead in the number of shots given to their respective populations, she points out. “That’s probably what is driving the return of business and consumer confidence,” she says.

The pace of vaccination, however, depends on the access to vaccination. Ling points out that developed markets (DMs) have greater access compared to emerging markets (EMs). This allows DMs to open their economies earlier, she says.

Monica Defend, global head of research at Amundi Asset Management, shares a similar view. She says the US has been leading and is at a “climax”. However, Europe has lagged, though the region will experience its economic momentum peak in 3Q this year, thanks to the vaccine roll-out and tourism season.

Defend adds that the growth premium between EMs and DMs is narrowing not only because most of the big EM economies — namely India and Brazil — are still in the grip of the pandemic. But also because growth has already peaked in China. “For our 2021 outlook, we now emphasise the unbalanced nature of the recovery,” she writes in a 2H2021 investment outlook report.

Like the uneven growth across economies, Singapore, too, is expected to see uneven growth across its sectors.

Among the bright spots are the manufacturing sector, especially the electronics cluster. Ling believes that the electronics cluster, which has rebounded earlier and faster compared to that after the Global Financial Crisis (GFC) in 2008, should see sufficient “momentum” ahead. This will arise from demand driven by 5G connectivity, work-from-home arrangements and the global chip shortage, she says.

That aside, the retail sector, which includes sales via physical and online channels, has been a positive surprise and should continue to do well ahead. Back in the period post-GFC, Ling says retail demand took “a while” to return. Retail sales volume, in fact, never recovered to levels seen before the GFC, she adds.

But in the current crisis, retail demand did not drop substantially but diverted to e-commerce. Ling points out that local online retail sales spiked to a high of about 25% during the “circuit breaker” last year. Although the spike in online retail sales has declined now and is likely to be unsustainable at that level, she believes online shopping is here to stay given permanent lifestyle changes.

Meanwhile, the construction and transport sectors continue to be challenging. Recovery in the former remains weak as the restriction measures and labour supply crunch have delayed ongoing projects. On the other hand, air passenger arrivals are only 3% of 2019 levels due to extended international border closure and travel restrictions.

Nevertheless, OCBC has forecast Singapore to achieve 6% GDP growth for 2021. The citystate is already off to a good start in 1Q with a y-o-y expansion of 1.3%, compared to a 2.4% contraction in 4Q last year. Although Singapore “hit a speed bump” in 2Q owing to the implementation of restrictive measures under Phase 2 (Heightened Alert), Ling believes the impact will be temporary.

Inflation fears

Yet, as growth picks up, inflation is picking up too, especially in the US.

In April, US CPI inflation rose 0.8% m-o-m, accelerating from the m-o-m rise of 0.6% in March. This was the highest since June 2009, CGS-CIMB Research highlights. Over the 12 months to April, the all-items index increased 4.2% before seasonal adjustment, up from 2.6% in the 12 months to March 21. This was the largest 12-month increase since September 2008, it adds.

CGS-CIMB, in a June 1 team report led by chief investment strategist Lim Say Boon, warns that the massive monetary shock will likely drive inflation much higher. It notes that this had previously happened many times in the US after rapid growth in money supply there. For instance, inflation spiked during the late 1870s towards the end of the so-called “Long Depression”, World War I, the Great Depression, World War II and the Vietnam War.

As the US has seen an unprecedented period of growth in M2 money supply over the past 12 months, inflation could spike again. M2 money supply refers to cash and checking deposits, saving deposits, money market securities, mutual funds and other time deposits. CGS-CIMB highlights that M2 money grew 30% from January 2020 to March, which has surpassed the previous peak of y-o-y M2 growth of 24% in 1943 during World War II.

No doubt, there are some exceptions. CGSCIMB notes that there were three monetary expansions when inflation did not spike: During the Nasdaq crash of 2000–2001, the GFC of 2008– 2009 and the post-GFC struggle for recovery.

“It is not a perfect match every time but there is sufficient history of the relationship between rapid money supply growth and inflation in the US to take the increase in monetary supply seriously,” states CGS-CIMB.

“Given the size of the monetary expansion this time — and it is worth repeating the word ‘unprecedented’ — it would be reckless to dismiss this as inconsequential,” the brokerage warns.

Nevertheless, Lee of BoS disagrees because he believes the spike in US inflation is likely to be “transitory” due to the low base effect. He also believes that the higher prices of goods and services are due to bottlenecks in the supply chain, which he expects to be temporary. Moreover, inflationary pressures from wage growth are unlikely to occur too, he adds.

Although he concedes that higher commodity prices can and have fuelled a significant rise in inflation, he stresses this is not always the case. Lee recalls that commodity prices had shot up in the early 2000s but the US core CPI was subdued.

What about Singapore? OCBC notes that domestic inflation has ticked higher amid domestic growth recovery, rising commodity prices, and the increase in private transport and accommodation costs. Compared to the low base in April last year, headline and core CPI rose 2.1% y-o-y and 0.6% y-o-y respectively.

However, the Monetary Authority of Singapore (MAS) has retained its 2021 headline and core CPI forecasts at 0.5%–1.5% y-o-y and 0%–1% y-o-y respectively. Although the central bank notes that there are some upside external inflation risks, it anticipates these pressures to ease in the latter part of this year. This, it says, is due to a surplus oil production and persistent negative output gaps in some of Singapore’s key trading partners.

For now, market observers believe that the Fed would not raise interest rates or reduce asset purchases anytime soon. CGS-CIMB says the US needs to maintain low rates for as long as it can hold out. According to the brokerage, the US has repeatedly, through most of the past century, engaged in monetary expansion to reflate itself out of trouble. And that involved secular weakening of the US dollar and inflation. Debt sustainability requires borrowing costs to be lower than nominal growth rates. “So, US policymakers will likely seek to raise nominal GDP growth through higher prices, while holding down the country’s sovereign borrowing costs,” says CGS-CIMB.

Another reason is the protection of corporate credits. A blowout in corporate bond yields and spreads could risk economic recovery, warns CGS-CIMB. The Fed had successfully prevented large-scale business failures in the US despite the sudden stop in cash flow caused by the Covid-19 pandemic. “It would not want to jeopardise its success by allowing borrowing costs to surge before cash flow is robust enough to withstand it,” says the brokerage.

Maybank Kim Eng believes that the Fed will maintain the current interest rates and pace of asset purchases at its upcoming meeting on June 15 and 16. With vaccination progress at an advanced stage in the US, diminishing threat of virus infections and economy reopening, the committee would describe the labour market as improving but still with “slacks”, it says.

MAS is also unlikely to turn hawkish. “I think our base view is not for MAS to tighten monetary policy in October yet,” says Ling. “We do think that Sibor is anchored.”

Mixed views

So, how should investors position themselves?

On the equity front, valuations are more than what the long-term expectations for earnings can justify, warns Amundi. This is likely unless the “roaring 20s” narrative of higher productivity growth, reflecting the one experienced at the beginning of the last century is embraced. “If this is not the case, as we believe, a pause in equity growth is expected,” say Amundi’s group chief investment officer Pascal Blanqué and deputy group chief investment officer Vincent Mortier.

“Market direction ahead will depend on how much further we have to go in terms of the peak in economic activity and how much of the temporary bounce in growth and inflation will become structural,” they add.

Chetan Seth, equity strategist at Nomura, says it is fair to assume that the Fed will be discussing about tapering in the coming months, which could be a source of market volatility. But he reckons that Asia excluding Japan equities should only experience short-lived volatility, if any.

According to Seth, tapering does not mean the Fed is no longer buying bonds. Rather, the central bank has started to buy fewer bonds. Secondly, Asia’s more vulnerable economies such as Indonesia and India have better economic fundamentals today than before.

Both countries have accumulated huge foreign exchange reserves and run current account surpluses, he says. “Therefore, we do not expect tapering to have a very disruptive impact on Asia equities,” he said in an outlook briefing on June 1.

In terms of stock selection, Seth notes that he had at the start of 2021 recommended value and cyclical stocks, which could see a strong outperformance. But now, the performance of these stocks is not so clear-cut.

“Rather than go for high growth, high valuation stocks, I think a better investment strategy is to look at some of the quality growth stocks, which are trading at relatively attractive valuations,” Seth says.

Lee of BoS also thinks cyclical stocks will underperform amid the peaks seen in growth and monetary stimulus as well as rising inflation which he believes will ease. But unlike Seth, Lee continues to see opportunities in technology stocks.

He reckons that as the market enters the mid-cycle phase of growth, technology stocks will continue to drive market appreciation like in the previous cycle. This will be driven by earnings growth of companies in the semiconductor and internet sectors, he says. “We see technology and high growth sectors leading the charge,” he says.

CGS-CIMB, however, has downgraded US equities to “neutral” from “overweight” to reflect the rising risks. The brokerage is now “overweight” on inflation hedge assets such as gold, commodities and real estate.

“These so-called hard assets are traditional refuges against inflation. Indeed, they have already been rising on fear of inflation. Also, they are cheap in a relative sense — that is, relative to equities and bonds,” says CGS-CIMB.

Photo: Bloomberg