From Inflation to Free Popcorn Bubble

Inflationary pressures remain the focus for now. According to Google, search interest for “inflation” is at an all-time high. It has also been largely discussed during the last companies’ earnings calls, especially the two main sources of inflation, that is the increase of supply costs (commodities, transportation, chip shortage, etc.); and the increase in wages, due principally to the difficulty of finding workers.

It seems that people currently receiving unemployment benefits till September are not in a rush to go back to work. As a result, in order to attract employees, many companies announced increases in salaries. With higher costs leading to increased prices, it does not look to us like inflation will be only transitory, as most of Fed and Treasury officials keep saying.

Note, that the only phenomenon that could be temporary is the comparative economic data which compares current economic performance to last year’s performance. This is at best quasi-irrelevant as last year’s numbers obviously reflect an economy that was then shut down.

While a rate hike is unlikely, the Fed could decide to reduce its bond purchases. Indeed, the release of the latest Fed meeting minutes gave some hints that such a move could possibly be announced during the next meetings – but more likely in July or September than in June. In Europe, the ECB made it clear that no tapering would happen before they see further evidence of a full economic recovery.

May was also marked by progress on the President’s massive infrastructure plan. Republicans made a $928 billion counteroffer to Biden’s $1.7 trillion original plan, proposing the use of existing funds for financing instead of a tax hike. A compromise must be negotiated and accepted by each side in order to pass the bill as soon as possible, as the Democrats wish to do.

On the ETFs side, ESG (Environmental, Social and Corporate Governance) ETFs, encountered more inflows than any other ETFs in Q1 and hit new records in terms of size. In addition, the new Ultra Short Bonds ETF of Vanguard, launched in April, has already raised $730 million, indicating that some cash is seeking to be invested on the sidelines for the time being.

Also interesting was the rebalancing of some of BlackRock’s ETFs. The giant asset manager decided to reduce the concentration and the volatility of its clean energy ETFs by adding a component of “energy transition” stocks, making the thematic ETFs a bit more mainstream. Moreover, it heavily rebalanced its USA Momentum Factor ETF, by switching most of the tech exposure with value stocks, especially Financials that now account for 1/3 of the ETF. An interesting new weighting, that although based on the past six months momentum, gives a clear indication of the outlook according to prominent actors.

Finally, May saw the fall of Bitcoin and the comeback of frenzied trading. After the cryptocurrency more than doubled in value in only a few months, one-third of its value was erased following Chinese regulators’ announcements and Musk’s tweets, both against the digital coin. Also, AMC Entertainment stock that was paired with GameStop during the Reddit saga in January made a comeback as traders’ favorite stock of the month: its shares were up more than 500% in one month only, based on nothing but meme-trendy-viral-trading.

The earnings season for the first quarter showed exceptional numbers and overall good guidance for the rest of the year. Since it is too early to price a rate hike, we continue to believe that, despite the current valuations, equity markets could be further supported. Having said that, everyone who follows the markets this year can feel the fragility and keep expecting the unexpected. In this context, we continue to reduce risk, to be prepared for an eventual sharp pullback.

As always, risk management combined with rigorous sector and geographical diversification will remain key factors for investment performance.

You are more than welcome to contact us to discuss our investment views or financial markets generally.

For a look at all of today’s economic events, check out our economic calendar.

Sell in May But Do Not Go Away…

During the different meetings last month, the various Central Banks, the Fed, Bank of Japan, People Bank of China, and the ECB left rates and policies unchanged as expected.

While the tone was quite optimistic on both sides of the Atlantic, Chairman Powell remained dovish and said the “time is not yet” to talk about tapering. Regarding inflation, Powell emphasized again that the Fed’s focus is on actual numbers and not on forecasts, and even if higher this year, the inflationary pressure should only be transitory.

However, last week Treasury Secretary Yellen shook the markets when she said that rising rates would be a necessary tool against an overheating economy. At the end of the day, the decision-maker regarding the rates is the Fed, but since Powell and Yellen are close, we may legitimately ask ourselves if they do not start questioning the inflation’s “temporary” nature.

During its meeting, the ECB said it would expect to lower bond purchases by the end of the year if vaccine rollout is improving and new variants do not represent a threat to the reopening.

In addition, the European Union plans to launch a Recovery Fund in June, under which it will issue a total of 800 billion EUR within five years, in order to support the post COVID economy.

The Central Banks in China, the US, and Europe are planning or checking a potential launch of a digital currency of their own – a move which may counter the original purpose of the cryptocurrency, a non-regulated coin.

Biden seems decided to finance his plans with tax hikes

In the US, President Biden seems decided to finance his plans with tax hikes: his $2.25 trillion infrastructure plan should be financed with an up to 28% corporate tax hike. He announced a $1.8 trillion children and families plan that should be financed with a tax increase as well. In addition, he proposed a capital gains tax hike from 20% to a 39.6% maximum rate for households making more than $1 million per year.

Of course, with a narrow majority in Congress, such increases will likely be compromised, but still, the tone is set, tax hikes will happen for corporates and for investors. An interesting and historical fact though: US markets tend to perform better in years of tax increases than during years of tax reduction. Food for thought…

On the vaccination side, Biden missed his target of 60% for the end of April. Nevertheless, even with 45% of Americans have received their first dose, restrictions are being eased all over the country. The new target is for 70% of Americans to get vaccinated by July 4th. In Europe, the vaccine rollout accelerated and as of today, 25% of Europeans have received their first jab. Israel is still a world leader with more than 62% of the population vaccinated.

April saw also the kickoff of the earnings season for Q1: so far 87% of the S&P 500 have reported, with 87% beating estimates. US major banks and giant techs reported extraordinarily strong numbers with good guidance, but little or no change was observed in their stock prices.

In the meantime, in China, regulators are focused on giant tech companies, and in this framework, Alibaba was fined $2.8 billion for breaking anti-monopoly laws, the largest amount ever imposed on a company. However, to put things in perspective, it represents only 2.5% of the forecasted revenue of the company for 2021 and the company accepted and complied with the charge without complaint. But for now, big Chinese stocks are under pressure mainly for that reason.

Virtual Climate Summit and the clean energy sector

Finally, a world leaders’ virtual summit on climate took place last month, organized by President Biden, hosting heads of states as well as philanthropists and activists on this matter. They all committed to efforts of lowering carbon emissions. This commitment has supported temporarily the clean energy sector. However, this sector is now suffering again, because of supply chain issues, despite actual good numbers.

Like automakers, renewable energy companies are being hit by the global chip shortage and by the cost of transport which has more than doubled this year. All that weighs particularly on solar energy companies that are in a period of development and investment.

From our side, as volatility and yields stabilize, and market movements on good news are contained, we tend to think that the recovery is now priced in and not much upside is left, at least in the short term. In this context, any bad news could have a strong and unexpected impact. However, for the midterm, two factors are incredibly supportive of the equity markets: first, the huge increase in dividend rates, even to above the pre-COVID levels, and secondly, the huge inflows into equity ETFs.

Indeed, inflows for the first quarter were the largest ever and more than three times the inflows during Q1 2020. If this trend continues, we could reach a total of $1 trillion cash brought to US equity ETFs by the end of the year, more than twice the actual record set in 2017. These facts tell us that there is plenty of money around and it mostly goes to one place, and one place only.

As always, risk management combined with rigorous sector and geographical diversification will remain key factors for investment performance.

You are more than welcome to contact us to discuss our investment views or financial markets generally.

For a look at all of today’s economic events, check out our economic calendar.

When the Black Swan Became White…

The rotation that had already started accelerated until the end of March: out of growth companies and into cyclicals. However, by the end of the month, investors’ appetite reverted into growth stocks and shares in the tech sector jumped again. This is the result of the recent optimism on the back of a quicker than expected economic recovery.

The fast reopening of the US economy is due to the vaccine rollout and the good news surrounding it. In addition to the available vaccines, Novavax vaccine may be approved next month by the FDA and Pfizer announced that tests showed its vaccine was safe for the 12-15 years old. President Biden’s target is now for 60% of Americans to be vaccinated by the end of the month and by that time all Americans should be eligible for vaccination. On the other side of the Atlantic, Europe is still struggling with more lockdowns and tighter restrictions, only 12-20% (depending on the country) having received the first dose.

Investors’ confidence, as well as the consumers’, was also boosted by the approval of the so expected $1.9 trillion stimulus in mid-March, and checks have already started to be received by eligible Americans.

Moreover, the last jobs report put numbers on this optimistic trend: jobs creation crushed analysts estimates, mainly coming from the leisure and hospitality sectors.

The VIX Index, which measures the market stress level, and which was itself volatile until recently, came back to pre-COVID levels, under 20, which represents a buying signal for traders.

Last month we also saw meetings of the ECB, the BoE, and the Federal Reserve who decided to leave rates unchanged and to maintain a dovish tone. The ECB and the Fed tried to reassure investors regarding inflation and rising yields. ECB chairwoman Lagarde said that the central bank will closely monitor the evolution of long-term yields, but she emphasized that it is not the ECB’s role to control the yield curve. However, after weekly bond purchases were relatively low during the first months of the year, the ECB has decided to increase them again.

On the currency side, while the yield differential is widening between the EUR and the USD, the USD strengthened last month and returned to November’s level which will help control inflation.

As for the markets movers of the first quarter, the best sector so far this year has been the Energy Sector, boosted by the performance of the oil price, +22% year-to-date. The price of oil should be sustained further, as during the last OPEC+ meeting, members agreed to maintain the same output for another month and starting from May, to gradually increase production.

On the other hand, the clean energy sector suffered outflows and a strong downside until Biden announced his $2.25 trillion infrastructure plan, in which clean energy is the epicenter. The sector rebounded by 8% on the news, and if signed this summer, this plan should be incredibly supportive to all the ESG linked investments. However, as the financing should come from a corporate tax hike to 28%, a Senate majority will be hard to obtain.

Among the most negative movers so far this year, Asian, US and European investment grade bonds have all sold off since the beginning of the year. Concerning Asian bonds, the strong sell off in both local and hard currency, was especially due to an improving economy in the US but also because of a stronger USD.

Chinese equities also had a negative first quarter but presented a buying opportunity to build a long-term position, on what is still the fastest growing major world economy. Concerning US-China relations, although two major officials from both sides met in Alaska during the last month to reopen talks, two recent events may have increased tensions again. First, Biden said he will not reduce the tariffs for now and secondly China has signed a 25-year agreement with Iran on economic activity and political affairs.

Finally, at the end of the month, a financial scandal shook markets and especially the banking sector: Archegos Capital was forced to unwind some $20 billion leveraged positions, causing a $4.7 billion hit for Credit Suisse. Following this episode, the Swiss bank announced a profit warning for Q1, and some senior managers even stepped down from their roles. Other banks involved with Archegos better managed the risk of margin calls and did not miss the occasion to congratulate their risk management.

The equity markets rebound is a feat when we consider that we just “celebrated” the anniversary of the pandemic’ first wave. This is not just euphoric: the last round of companies’ earnings showed growth. In addition, as the global economy reopens, data and forecasts will also improve. Therefore, we maintain our high convictions, and lately we took advantage of the weaknesses to increase some of our niche investments.

As always, risk management combined with rigorous sector and geographical diversification will remain key factors for investment performance.

Sweetwood Capital provides asset management and investment advisory services to qualified high net-worth individuals. Our aim is to achieve consistent cash-flow generation for our clients through direct investments in transparent and liquid instruments. We offer a highly personalized service and construct investment portfolios that are calibrated to the risk vs. reward preferences of each client. Our clients do not take any counterparty risk through us as their assets are held in their own bank.

You are more than welcome to contact us to discuss our investment views or financial markets generally.

For a look at all of today’s economic events, check out our economic calendar.