On the fundamentals front, the European economy remains very strong. Both manufacturing PMI and services PMI reached record high levels, other important sentiment indices are also encouraging, with the economic sentiment index setting a new record high, and consumer confidence reached the highest level since 2018. With the economic fundamentals back to pre-pandemic levels and the COVID epidemic under control for most European countries, the European equity market is well set for good performance.

In Q3 2021, we favour European equities over other developed markets. Apart from the solid fundamentals to support the local economy and corporate earnings, monetary policy is expected to stay more supportive than the US, as inflation in Europe remains rather mild, ECB’s new strategy on inflation further ensures that there will be no tightening in the short term. President Christine Lagarde claimed that the European economy remains fragile and the supportive monetary policy would likely stay in place at least until the end of March 2022. With the relatively robust economy and an abundance of liquidity, European equities will likely be the market in focus for Q3 this year.

On the fundamental side, although the economy is still in the expansion zone, the momentum of the Chinese economy does seem to be slowing down. As the low base effect fades out, economic indicators continue to fall. This could have implications for the market, as it could imply that the economic recovery from the epidemic exit is fading, such that we are entering late cycle economic expansion. To top it off, liquidity shortage has been one of the main limitations on the market performance, despite the strong economy and corporate earnings.

For the remaining half of the year, we still expect monetary policy in China to remain modest, where further gain in the equity market would depend more on corporate earnings growth. As we enter the late cycle, the new economy sector will return as one of the segments in focus, as valuations of quality growth companies are attractive, partly due to a surprise ban on DiDi, which impacted market sentiments. Henceforth, for the remaining half of the year, we would prefer to pick individual quality companies in the Chinese equity market, as the overall market should remain under pressure.

The economy in the US is still going strong, PMIs remain in the expansion zone, while new job creations were also supportive to the economy. However, we also do note that the figures were less positive than markets expectations, which could suggest that peak recovery is possibly over. Another thing to consider is the jobs market, even though initial jobless claims fell below the 400,000 mark once again, the employment level is still far below pre-pandemic levels, which is a point of concern.

More importantly, inflation levels in the US remain elevated, which poses a threat to the current loose monetary policy. Although Fed chairman Jerome Powell have repeatedly said that the current inflation is transitory in nature, other Fed members have voiced out their support for an earlier scale back in QE size. With the market currently pricing in half a rate hike by the end of 2022, market expects less monetary support to the equity markets. While we are still positive on the US market, we’ll opt for a balanced approach on both growth and value, and expect less upside due to the anticipated tightening liquidity.

 US

Despite the inflation in the US reaching a post-2008 record high, the Fed Chairman maintained his dovish stance, which was positive for market sentiment, as the U.S. stock market hovered around its all-time high. Over the past 5 days ending Thursday, the Dow gained 1.64%, the S&P 500 rose 0.91%, while the NASDAQ was weighed down by technology stocks, down 0.11%. The US Consumer Price Index (CPI) rose by 5.4% YoY in June, the largest jump since 2008, although US Federal Reserve officials said inflation was only transitory, different governors expressed divergent views on the monetary policy. Chairman Powell stressed that it was not the time to taper bond purchases, while the St. Louis Fed President urged a tapering of bond purchases, saying that both employment and inflation targets had been met; the Chicago Fed President said policy should be adjusted by the end of the year, and interest rate hikes would have to wait until 2024. US Treasury Secretary Yellen said she would discuss with President Joe Biden whether to nominate Powell for a second term, and the market is assessing the impact of different candidates on the administration's monetary policy. As for crude oil prices, upward pressure was eased in the short term as the deadlock in the UAE-Saudi Arabia talks showed signs of easing, with OPEC+ expected to reach consensus on increasing production. The Organization of the Petroleum Exporting Countries (OPEC) is forecasting a gradual recovery in oil demand for this year and the next. Next week, the US Manufacturing and Services PMIs will be released.

Europe

European equities as a whole followed the US market and consolidated at all-time highs, the French and German markets gained 1.51% and 1.36% over the past 5 days ending Thursday, while the UK index fell 0.27%. European Central Bank (ECB) Board member Isabel Schnabel said the ECB would need to see a rise in core inflation before considering adjusting its outlook and tightening its policy. President Christine Lagarde said in an interview that the ECB would not tighten policy prematurely as it did in the past to avoid repeating the same mistakes. On the other hand, the EU finance ministers approved an investment plan for 12 member states which, according to the EU executive committee, is estimated to be worth €800 billion and could boost public investment to 3.5% of the region's GDP next year, in a bid to boost the recovery after the epidemic. Next week, the ECB will hold an interest rate meeting on 22 July, and the Eurozone will also release manufacturing PMI data for July.

China

Despite the recent choppy sessions in the Mainland markets, Hong Kong equities rebounded on the back of dovish signals from the US, and expectations of the return of Chinese companies to the city, the CSI 300 Index rose 0.5% for the week, while the Hang Seng Index was up 2.41%. On Friday, news that China may waive cyber security checks for Hong Kong-listed companies reinforced expectations of more Chinese companies returning to the Hong Kong market, shares of HKEx hit a five-month high. China's GDP grew by 7.9% YoY in the second quarter, roughly in line with market expectations, indicating a stabilisation of the economy. China will announce the quoted market rates for 1-year and 5-year loans, LPR.

 US

US stocks erased much of their previous gains on Thursday alone, amid concerns that the US economic impetus may be slowing down. In spite of the Thursday drawdown, US stocks still outperformed the other major equity markets over the past five days ending Thursday, with the S&P 500 and NASDAQ up 0.54% and 0.38% respectively. On the US data front, the labour market continued to improve, with a record number of 9.2 million job openings in May, reflecting further strengthening of the job market. However, the pace of expansion in the US service sector, reflecting service sector activity, was weaker than expected in June, raising concerns that the US economic growth momentum may have peaked, triggering a market correction. Longer-term inflation pressures have eased as the 30-year US Treasury yield, typically reflecting longer-term inflation expectations, fell to 1.85%, down 66 basis points from its high of 2.51% in March. The minutes of the June meeting of the US Federal Reserve showed that officials expect the timing of the tapering could be earlier, but remain divided on how to scale back purchases of mortgage-backed securities (MBS).

Global oil prices continue to rise, mainly due to concerns over the supply outlook as Saudi Arabia and the UAE failed to reach an agreement on increasing production. No announcement has been made regarding the next OPEC+ meeting, which may mean that production will probably stay unchanged in August, possibly resulting in a 'historic supply gap', and this has spurred a further rise in oil prices to near US$77 per barrel. The market is still closely monitoring oil price action. Next week, the US will release important data such as CPI and retail sales for June, and the Fed will also publish its latest economic beige book.

Europe

European stock markets have been weak recently, with the UK, French, and German equity indices down 1.33%, 2.40% and 1.17% respectively over the past 5 days ending Thursday. The ECB announced the results of its first strategy review since 2003, stating that a medium-term "symmetric" inflation target of 2% will be implemented from 22 July onwards, while allowing inflation to "moderately" exceed this level temporarily. ECB president Christine Lagarde said that the new inflation target does not preclude any potential policy tightening, which was unanimously agreed by central bank policymakers. On the other hand, the European Commission raised its economic growth forecast for the Eurozone from 4.3% to 4.8% this year, saying that the economy is "recovering strongly". Next week, the UK will release CPI data for June.

China

The investigation of DiDi has renewed regulatory concerns in China, and the sharp fall in China concept stocks weighed on the performance of the Hong Kong stock market. The Hang Seng Index was down 3.41% for the week, while the mainland stock market fared better, the CSI 300 Index was slightly lower by 0.23% for the week.  The freshly US-listed vehicles for hire leader DiDi is under investigation, with its share price falling by nearly 20% in a single day after its IPO, and its shares have been in a downward spiral since then, to the extent that US investors have taken it to court. It is reported that the Chinese government may tighten up the supervision of companies listing abroad. On the other hand, China's bond market was supported by the State Council's reintroduction of "timely RRR cuts", which saw the 10-year bond yield briefly falling below 3%. Next week, China will announce its GDP for the second quarter and important data on fixed investment, production and retail sales in June.

 US

US equities stayed in strong form, as concerns over the risk of rate hikes and tapering has temporarily faded, positive economic data further supported markets. Over the past 5 days ending Thursday, US markets went higher, the 3 major equity indices gained 1.06 – 1.28%, the S&P 500 Index in particular set new historic highs for 6 days in a row. Policy wise, the bipartisan infrastructure bill has hit another obstacle, as Republican senators warned that they could withdraw their support for the bipartisan deal if it was bundled with another Democratic bill. Economic data were great, initial jobless claims went below 400k again, hitting a new low since the start of the epidemic. ISM manufacturing PMI fell slightly short of market expectations, but remains in the expansionary zone, consumer confidence also hit a recent high, both highlighting the strength of the current economy. As for monetary policies, Philadelphia Fed Chairman Patrick Harker said the reduction in asset purchases should start within this year, joining in with the growing hawkish sentiment in the Fed. Next week, services PMI from both ISM and Markit will be released, investors might also want to keep an eye out for the latest employment data, while the Fed will release the June FOMC meeting minutes.

Europe

European equities had mixed performance amidst decent economic data, the UK and German equity indices gained 0.09 - 0.21% over the past 5 days ending Thursday, while French equities lost 1.17% over the same period. Although vaccinations programmes continued, COVID infections in the UK due to the Delta variant are on the rise, which could risk spreading it across the continent with the ongoing UEFA EURO 2020, potentially jeopardising the whole reopening process. Apart from the risk arising from the epidemic, Europe fundamentals remained on the bright side, with various employment, sentiment, and more importantly inflationary data staying on the positive side. The latest figure on inflation came in at 1.9%, which is slightly lower than the previous figure of 2.0%, relieving markets over inflation concerns, and indirectly guaranteeing that the current easy monetary policy can be extended. Next week, Europe will release a range of key economic data, including services PMIs and retails sales figures, while Germany will have further data on ZEW Survey Expectations and industrial production.

China

With a larger correction on Friday, Chinese equity markets underperformed, the CSI 300 index lost 3.03% over the week; Hong Kong markets also felt the impact, falling 1.98% over the past 5 trading days ending Friday. As for fundamentals, economic data in China was less positive than markets had hoped, with both the official PMIs and the Caixin manufacturing PMI lower than the previous reading. The Chinese Communist Party celebrated its 100th anniversary, marking the end of the first centenary, and moving on to the second centenary, which aims to transform China into a modern world power. Markets continued to pay attention to the offshore corporate bond markets, with the recently downgraded Evergrande and Huarong in focus. Next week, China will release more economic data, including Caixin services PMI, CPI, and PPI figures for June.

 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.