US

US stocks continued to reach new highs as President Joe Biden and a bipartisan group of Senators reached a preliminary agreement on a US$579 billion infrastructure plan that, if implemented, could bring further support to the recovering US economy, this helped boost the US equity markets to new record highs. Over the past 5 days ending Thursday, the three major US stock indices gained between 1.06% and 1.47%. US Senate Majority Leader Schumer hoped that the Senate would consider the bipartisan infrastructure bill so that the plan could be finalised this summer.

The US economy remains strong, with durable orders increasing in May by the largest amount since January this year, the Markit manufacturing PMI continued to reach a record high in June, although the service PMI slowed. Behind the strength of the economy, the market is worried about rampant inflation and the risk of interest rate hikes, with the Chairmen of the Dallas and Atlanta Feds both saying they expect interest rate hikes to begin next year, while hinting that a reduction in quantitative easing could start in the next few months. On the epidemic front, the Centre for Disease Control and Prevention (CDC) said the Delta variant is spreading rapidly and now accounts for one-fifth of all new cases in the US. The market is concerned whether the strong data from the US will continue, the ISM manufacturing PMI, consumer confidence index and unemployment rate releasing next week will likely give colour to the matter.

Europe

European stocks underperformed against the rest of the world, with the UK, French, and German equity markets falling between 0.53% and 0.58% respectively over the past 5 days ending Thursday. The Bank of England kept its monetary policy unchanged after the latest interest rate meeting and raised its inflation forecast, but stated that the surge in inflation was only transitory. Eurozone data suggest that the economy is still in recovery, with ECB vice-president Luis de Guindos expecting "significant" economic growth in the second half of the year. Isabel Schnabel, another member of the central bank's executive committee, also stated that the bank would do its utmost to support the economic recovery on the monetary policy front, while warning regional governments against a premature tightening of fiscal support. Next week, the Eurozone will release unemployment and inflation figures, with the unemployment rate expected to remain unchanged and the inflation pace slowing YoY.

China

Chinese stock markets have seen heightened activity, the CSI 300 Index rose 2.69% over the week, posting its fourth consecutive day of gains, while turnover in both Shanghai and Shenzhen stock exchanges topped RMB1 trillion on both Thursday and Friday; whilst Hong Kong markets were buoyed by optimism in the A-share market, with the HSI rising 1.67% over the same period.  On the data front, the profit growth of Chinese state-owned enterprises accelerated, with the total profit of state-owned and state-controlled enterprises in the first five months of this year amounting to RMB179.39 billion, equating to an increase of 1.7 times YoY. On the other hand, the People's Bank of China and four other ministries jointly launched fee reduction measures to provide continued support to the real economy, which are expected to reduce the total amount of handling fees by approximately RMB24 billion. Next week, China will release the official manufacturing PMI and Caixin PMIs.

Fed officials have insisted repeatedly that the current inflation is merely transitory, which would not threaten the long term stability in the economy. The sentiment is echoed over the other side of the Atlantic, where the European Central Bank (ECB) officials see no immediate inflationary pressures, and reiterated the decision to keep the Pandemic Emergency Purchase Programme (PEPP) unchanged at least well into 2022. An unchanged monetary policy direction should continue support bond prices.

Over in the US, as revealed by the latest Fed minutes, Fed members are still evaluating whether it is the right timing for tapering discussion. According to the latest PCE and CPI figures, inflationary figures are running significantly higher than the historic trend, the current supportive monetary policy could end sooner than expected, which poses an interest rate risk to bondholders. Considering the narrow credit spreads in the US and European bond markets, we would prefer Asian names for the better risk to return ratio, and continue to stay short on duration in fear of possible tapering.

Extending last month’s record, economic fundamentals in Japan remain weak, which was a product of the weaker growth potential, and depressed economy outlook due to the epidemic. The 2021 Q1 GDP went negative once again, and was worse than the expected figure, outlining the weak economy in the country. Other fundamental indicators, including industrial production, and retail sales, fell short of expectations, which further supports a weaker outlook on the Japanese economy.

The problems further compounded with the ongoing epidemic in the country, where cases remained at elevated levels. More crucially, the key to a full economy recovery, vaccination progress, have remained sluggish, which could possibly slowdown future economic growth. Henceforth, our view on the Japan equity market remains unchanged – the cyclical trade could benefit the market to a certain extent, but country’s soft fundamentals likely pose a larger risk, we would avoid overweighing the market.

While the rebound in EM equities were formidable, we stand by our view on the DM EM divide. We still see DM equities outperform EM equities over the next few months and for the whole year. The factors we see leading to the DM EM discrepancy has not dissipated, as the risks arising from the slow vaccination progress, mounting external debt, and inflationary risks still looms on the horizon. With the significantly higher exposure to such unhedgeable risks, we find it difficult to make a case for investing in in EM equities at the moment.

One of the key factors lies in the epidemic control, one area which we find the DM economies is doing manifolds better than EM. As EM vaccination progress remains largely lagging behind DM economies, a true reopening is still out of the question, future flare ups can also cause serious disruptions to normal economic activities, as illustrated by the recent outbreaks in Vietnam and Taiwan. Although WHO’s recent approval of additional vaccines for emergency use could help alleviate some of the vaccine supply issues, we still see the outlook of EM as less attractive than their DM counterparts. As fundamental issues are yet to be resolved, we maintain our view of DM over EM in the short to mid-term.

Monetary policy is expected to stay supportive to the market well beyond this year. ECB officials mentioned that there is no intention to roll back on the scale of the ongoing Pandemic Emergency Purchase Programme (PEPP) before March 2022, ECB president Christine Lagarde also promised that the ECB will keep the accommodative monetary policy unchanged ‘well into the recovery’. As inflationary pressures in the region remain rather benign compared to other major economies, we could expect the equity market to remain supported by the excess liquidity throughout the year. 

Solid fundamentals across the region also provided extra confidence to the market, important indicators including PMIs and various sentiment indicators stayed strong and beat market expectations. Given the strong sentiment, the key to a sustained economic recovery lies in the pandemic control in the region. With around 50% of the European population having received at least 1 dose of vaccine, European Commissioner for Internal Market Thierry Breton estimates that the region could reach herd immunity by mid-July. That said, keep in mind that the European overweigh is primarily a short term tactical allocation, and we will review the recommendation by the end of the second quarter.

 US

The Fed's dot plot showed officials taking an unexpected hawkish turn, dragging US equities lower, while the tech sector defied the market, gaining on the back of a flattening yield curve. Over the past 5 days ending Thursday, both the S&P 500 and the Dow lost 0.41% and 1.86% respectively, while the NASDAQ gained 1.01% on the back of the tech rebound. After the interest rate meeting, the Fed announced no changes to its asset purchase program, but raised the overnight reverse repo rate and the excess reserve ratio, while also raising its inflation forecast for 2021 to 2023. The Fed's dot plot showed that more officials expects interest rate hikes to start in 2022, up from 4 to 7. The hawkish turn surprised the market and increased short-term volatility, equities retreated and the Dollar rallied, gold prices fell, longer-term treasury yields fell as the yield curve flattened. 

US Treasury Secretary Janet Yellen said the economy was recovering from the impact of the COVID epidemic and hoped the Congress would support Biden's budget proposal. However, US economic data showed signs of a slowdown amidst recent strength. Retail sales figures in May were weaker than expected, falling 1.3% MoM, the number of initial jobless claims also rose for the first time since April, while the Producer Price Index (PPI) accelerated to 6.6% YoY, reflecting higher upstream prices. Next week, the US will release the June manufacturing and services PMI, alongside May core PCE data.

Europe

European equities outperformed the rest of the world recently, with the UK, French, and German equity indices up 0.27%, 0.99%, and 0.22% respectively over the past 5 days ending Thursday. The market still believes that the EU and the European Central Bank (ECB) will not make changes to the current supportive policy direction. It was further reported that the ECB would extend an epidemic relief measure for banks for another nine months. The EU has also announced a 10-year bond issue, raising €20 billion as an initial funding for the EU recovery fund. Next week, the Bank of England will hold an interest rate meeting and Germany will release its IFO economic forecast for June.

China

The Hong Kong and Chinese stock markets saw divergent results, the CSI 300 index fell 3.21% over the week, while the HSI edged up 0.22% over the same period. China's economy held steady, although consumer spending, manufacturing output and fixed investment growth slowed in May YoY. Chinese authorities have recently shifted their attention over commodities, agricultural prices and the foreign exchange market. The market was also concerned about the mainland housing bond market, where data showed that the YTD share of bond issuance by lower-rated real estate entities fell to the lowest level in over a decade. The market remains focused on Chinese policy implications on the market.

Fundamentally, economic indicators, including various PMIs and other concurrent indicators, mostly remain in the positive zone, but we also do note that the numbers have actually been trending down in the recent months, which is likely a result of the low base effect wearing off. Overall, the Chinese economy is still doing decent, despite the recent slowing down. With the corporate earnings on the rise, picking high quality assets with robust earnings and lower valuation volatility should be the priority.

The more important issue in the Chinese market lies on the policy direction. As the Chinese equity market hit recent highs early on in the year, authorities emphasised the importance of stability, reducing liquidity to clampdown on excessive speculation, China’s money supply M2 has since then returned to pre-pandemic levels. Historically, during periods of slower money supply growth in relative to GDP, stock performance tends to be weaker, as the tight liquidity in the market limits the valuation levels in the market. With the current money supply staying tight, expect valuation expansion to be limited in the short to medium term. That said, while the monetary base is a limiting factor, with the economy steady and corporate earnings recovering, we maintain our neutral outlook on the Chinese equity market.

In fact, fundamentals remain very strong in the US. PMIs stayed strong, services PMI in particular set a new record high of 70.1. Employment data were also satisfactory, ADP nonfarm payrolls were outstanding, with initial jobless claims falling below the 400,000 mark for the first time since the epidemic started, suggesting that the epidemic’s grip on the economy might have been past its peak. With the recovery plays still under way, expect cyclical sectors such as financials, materials, and industrials to perform well.

Overall, we remain positive on the US market over the year. Vaccination progress in the US continues to progress, the domestic economy will recover, especially the badly hit industries of travel and leisure. However, risks do remain in the equity market, considering the current valuation levels. Given that recent inflation data is rising rapidly, Fed officials have mentioned that there should be discussion over future tapering talks, which suggests possible earlier than expected tapering, if inflation proves to be sustained. Henceforth, while we stay positive over the overall US stock market, be aware of the risks from tightening liquidity, emphasis should be placed on cyclicals sectors, and ones with growth potential and a stronger earnings conviction.