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.

 US

While the economic data doesn’t seem to be too supportive of the market, statements from Fed officials continued to reassure the market, market participants reacted positively. The tech sector in particular bounced further, the NASDAQ index gained 2.98% over the past 5 days ending Thursday, and the S&P 500 index was up 1.10% over the same period, while the Dow was down by 0.32%. The latest CPI figure released on Thursday came in as 5% YoY, which was one of the largest figures in recent years, and exceeded both market expectations and the previous figure. Even if we disregard peripheral data, core CPI was still up by 3.8% YoY, which was the largest figure since 1992.

As the economy is still in the early stages of economy reopening, market expects the Fed to reiterate that the current spike as merely a transitory phenomenon, and any signs of change in monetary policy is expected to be revealed at the Jackson Hole meeting in August. Believing that the risk of a short term monetary tightening has decreased, bond yields flattened on Thursday, while rate sensitive growth stocks rebounded. Next week, the US will release figures on retail sales, while the Fed will also hold an interest rate meeting. Market expects the Fed to maintain the transitory inflation rhetoric unchanged.

Europe

European markets were softer over the week with the mixed economic data released over the week.  Over the past 5 days ending Thursday, the UK and French equity indexes gained 0.34% and 0.59%, while the German DAX lost 0.39%. Fundamentally, 2021 Q1 GDP for the Eurozone was slightly better than market expectations yet remained in contraction, while industrial production figures missed market expectations, as well as the ZEW economic sentiment. On the monetary side, European Central Bank (ECB) President Christine Lagarde rejected the notion that the European inflation could be sustained, stating that inflation is expected to stay below the longer term target over the projection, downplaying the possibility of an early tapering coming from the ECB. The Bank also revised the GDP projections for the Eurozone up to 4.6% in 2021 and 4.7% in 2022.  Next week, the UK will release their unemployment figures and CPI data, Eurozone countries will also release their final CPI figures for May.

China

Chinese equity markets slightly faltered over the week, tightening liquidity conditions continued to pose as an obstacle to equity performance. The CSI 300 and Shanghai composite were both down again over the week, the Hong Kong HSI also underperformed, falling 0.26% over the week. The latest CPI figures in China were lower than market expectations, the mild figure was reassuring for markets, but the spike in PPI to 9.0% YoY is the highest number since 2008. The latest total aggregate financing figure fell short of market expectations, but still gained MoM, reflecting the liquidity in the onshore market. Next week, China will release figures for fixed assets investment, retail sales, and industrial production.

 US

The latest economic data were very encouraging, but talks of inflation weighed down on markets, as fears of monetary tightening led to the continued downward pressure on the tech sector. Over the past 5 days ending Thursday, only the cyclical heavy Dow Jones managed to post a gain of 0.74%, while the S&P 500 and NASDAQ fell 0.07% and 0.90% respectively. The US released a number of important data over the week, headline figures for sentiment indicators and employment data were all positive, services PMI in particular hit a new record high of 70.4, initial jobless claims also dropped below the 400k level for the first time since the epidemic has started. All the positive economic indicators point to a strong recovery in the economy, reports that President Biden is considering shelfing tax hike plans further supported equity performance. 

However, worries over inflation rose, the possible tightening up on liquidity in the future put more pressure on the growth heavy tech sector. Philadelphia Fed chair Patrick Harker recently mentioned that it is about time to think about tapering talks, echoing the two Fed vice chairpersons’ view, implying that the current easy monetary policy could possibly see an earlier than expected adjustment. In other news, the gold rally hit the brakes, seeing a 1.45% drop on Thursday. Next week, more data will be released, NFIB Small Business Optimism and University of Michigan Sentiment could further reaffirm the current business conditions, while any surprises in the CPI data for May could have implications for the monetary direction.

Europe

European market sentiment stays positive with its favourable economic outlook, and the supportive central bank policy tone buoyed European markets. Over the past 5 days ending Thursday, the UK, French, and German equity indexes were up by 0.53 – 1.47%. Data wise, Europe is still doing great, PMI figures across European countries were great, employment data was also positive. More importantly, while inflation jumped to 2.0% in the region, the figure remains roughly in line with central bank targets, fears of liquidity tightening or even rate hikes were still mostly out of the picture. ECB chairperson Christian Lagarde said that the Bank will keep policy support in place ‘well into the recovery’, market expects that the ongoing Pandemic emergency purchase programme (PEPP) will be kept in place well into next year. Next week, Germany will release its latest ZEW survey expectations, while the ECB will hold its June interest rate meeting, expect to hear more on the PEPP plans for the remaining half of the year.

China

Chinese equity markets were relatively muted over the week, as the latest economic data coming out of the country were mixed, tight liquidity conditions in the onshore markets also limited valuation expansions. The CSI300 and Shanghai composite were both down over the week, while the HSI was also dragged by the volatile markets and was down by 0.71%. It was reported that China is considering a cut in stamp duties, the equity market rebounded on Friday upon the news. However, this is still not enough to reverse the recent falling trend. Economic data this week had one surprise, as the official manufacturing PMI fell short of expectations, coming in at 51.1, whilst other figures remained in the expansionary zone. Next week, China will release figures on CPI, PPI, and exports.

 US

The revised US GDP growth for 2021 Q1 was unchanged from the earlier initial value, and the recovery trade continued to support the market. The Russell 2000 small cap index in particular benefitted from the strong domestic economy and outperformed other major equity indices, the index was up 2.96% over the past 5 days ending Thursday, while the S&P 500, Dow and NASDAQ were up 1.00%, 1.12%, and 1.48% respectively over the same period.  Although US Federal Reserve officials have repeatedly downplayed the risk of inflation, two Fed vice chairmen have also expressed interest in future tapering discussion. In the face of accelerating inflation, US President Joe Biden said that measures would be taken in the coming weeks to ease the supply pressure, including construction materials among other things. US Treasury Secretary Yellen gave a timeline for the inflation outlook, predicting a higher-than-normal rate for the year.

With the Biden administration set to announce its budget soon, it was reported that US federal spending will rise sharply to US$6 trillion in the next fiscal year, and that the US federal debt will reach 117% of GDP over the next decade. So far, members of both parties have expressed reservations over Biden's budget proposal. Incidentally, there are reports that the Bank of Japan will consider extending its epidemic relief measures for another six months, which are originally due to expire in September, while the IOC has said that both the EU and Japan have reiterated their support for a safe Tokyo Olympics. Next week, the US will release CPI and employment data for May.

Europe

European shares followed global markets higher on the back of positive economic data, with the UK, French and German equity indices gaining between 0.02% and 0.77% over the past 5 days ending Thursday. The Eurozone economy continued to improve, with the preliminary consumer confidence index rising from -8.1 in April to -5.1 in May, and the improving economic data also cooled expectations of further monetary easing from the European Central Bank, a Bank of England official even hinted at the possibility of an earlier rate hike. However, ECB President Christine Lagarde said that it was still too early for the central bank to consider scaling back its €1.85 trillion pandemic emergency purchase programme (PEPP). She noted that the ECB is committed to using the PEPP to maintain favourable financing conditions until at least March 2022. Next week, the Eurozone will release unemployment rate for April and CPI data for May.

China

Hong Kong stocks benefited from the expectations of the southbound fund flows, driving the Hang Seng Index up by 2.34% over the week, while the CSI 300 Index rose 3.64%. On the Hong Kong side, the MSCI index changes took effect after Thursday's market close, where about HK$90 billion of transactions were recorded during the closing auction, pushing the market turnover up to HK$250.5 billion. On the other hand, the RMB continued to appreciate in tandem with rising raw material prices, reaching its highest level against the US dollar since 2018. However, the People's Bank of China said that the RMB exchange rate is not a tool to offset the rise in commodity prices. Next week, China will release data such as the official manufacturing PMI and the Caixin China Manufacturing PMI.

Markets have shifted their views as it seemed that the inflationary pressure was not as serious as thought, driving the shift in yield curve this month, which differed from the recent trend, propping investment grades up. We see this shift only as a temporary change, as commodities prices remain at an all-time high, and the supply gap will not likely be closed in the short term, this would likely translate to more inflation pressures over the short to mid-term, putting downward pressure on bond prices, especially for investment grades.

In fact, Treasury Secretary Janet Yellen was caught talking about a possible rise in interest rate top prevent the economy from overheating. That could had been a slip of the tongue as she downplayed the comments, claiming that she sees no inflation pressure, but this underpins the reality that inflation risk is too in the minds of the Fed, and a rate hike in the midterm is certainly not out of question. Henceforth, we are keeping our views on the fixed income market unchanged, high yields all the way, as their risk to return profile is better suited to the current market condition and outlook. 
 

Economic data was mixed. While household spending and machinery orders were lacking, PMIs, retail sales, and industrial production posted positive numbers, although services PMI remained in the contractionary zone. In our view, the economy should continue to recover, but the recovery will likely be lagging behind other developed markets due to the government’s incoherent pandemic strategy, and the slow vaccine rollout means any full reopening will likely take time.

According to the latest public opinion, nearly 60% of responding Japanese wants the Olympics to be cancelled on public health grounds. With no foreign visitors allowed at the Olympics, all sunk costs of hosting the Olympics will be largely unsalvageable. As the state of emergency has been extended once again, citizens have vented their frustrations with the government in form of disapproval against Prime Minister Suga, whose support recently hit a new low. The outlook of the Japanese market remains muted as a result of the government’s mishandling, and the long term growth profile is unfavourable, we would avoid overweighing in the market.
 

We still favour developed markets over emerging markets, mainly because of risks that will likely hold true in the future. The 3 main risks are still in play: vaccination progression is slow in emerging market countries, inflationary pressures continue to mount, and the current fiscal deficit will likely be unsustainable. These primarily affect emerging markets more, which would likely result in the DM’s future outperformance over EMs.

Furthermore, the worsening epidemic in emerging market countries seems to be back on the menu, as we saw record daily infection figures come out of India. This is likely inevitable as pandemic fatigue kicks in, but vaccinations in emerging countries have yet to cover the lost ground. To make matters worse, recent statements over the AstraZeneca vaccine painted it in a bad light by highlighting the risks of rare blood clots, possibly damaging the confidence in these vaccines, which were supposed to be the key for emerging economic to achieve herd immunity. This could have profound effects on the outlook of the EM economy, further solidifying our view of “DM over EM”.