Over the past year, earnings announcements have been highly anticipated by the markets as the COVID-19 pandemic caused unprecedented uncertainty on the bottom line of the largest international corporations.
During the past six weeks, the majority of the companies listed on the major market indices have been reporting their first quarter (Q1) results. Given the valuations at which markets had been trading prior to the start of this earnings season, the bar was set high and hence, despite the flow of positive news on the vaccine front and the unprecedented fiscal and monetary support, there was significant room for disappointment if earnings failed to jump over the hurdle.
An impressive 86 per cent of the US and 72 per cent of the European companies have beaten earnings expectations to fuel the optimism that the major economies will register a rapid rebound and return to pre-pandemic levels over the coming 18 months.
Moreover, economic data has extended its positive pattern with the first quarter global Gross Domestic Product (GDP) registering a 6.4 per cent annualised rate, while business surveys, like the Purchasing Managers Index (PMI), reached a near-14-year high. Such data is further proof that the major economies are on the doorstep of a reflationary period, whereby the level of output in the economy is increasing through interventions by governments and central banks. This rebound was registered despite a spike in COVID-19 cases in the first three months of the year and the consequent reintroduction of specific lockdown restrictions.
The main risks to this economic rebound stem from a rushed tapering by the major central banks and further development of new COVID-19 variants. Over the past 12 months the major economies were solely dependent on the loose monetary and fiscal policies that were implemented. Despite the encouraging data, the unwavering support of governments and central banks will be crucial to return to pre-COVID levels. Both Christine Lagarde, president of the European Central Bank, and Jerome Powell, chair of the US Federal Reserve, have constantly assured markets that they will sustain their support to their respective economies. Both Lagarde and Powell will have to juggle their policies while managing the risks of an overshoot in inflation.
This economic rebound is leading to a substantial pick-up in yields despite the unaltered policies of the major central banks. The rise in yields is being driven by the rebound in inflation due the combination of global growth and bottlenecks in major supply chain. The inflation phenomena is expected to be the main source of volatility in markets as consumer inflation has already reached the 2.6 per cent level in the US and 1.3 per cent in the eurozone.
Given the factors discussed above, we are experiencing the much-awaited growth-to-value rotation, whereby fund managers are shifting their allocations towards inflation and higher-yields beneficiaries like energy, financials, materials and a selective part of the consumer discretionary sectors.
On the other hand, the fixed income market has experienced a turbulent start to the year on the back of the spike in yields. Fixed income investors have had a relatively comfortable ride over the past 13 years as the low yielding environment and the central banks’ purchasing programmes created unprecedented demand for investment grade bonds. The recent developments are requiring investors to shield their fixed income allocations from interest rate sensitivity by decreasing the duration of their holdings.
Going forward, for the current market levels to be maintained will demand this rebound to maintain its pace and for earnings per share growth (EPS growth) to beat expectations. The vaccination process and the ultimate return to normality will be crucial for the major economies to reach their respective potential outputs over the next 18 months.
Governments will have to implement their reopening programmes while avoiding any further breakouts in COVID-19 infections. This environment will require active investors to be vigilant in the allocations of their respective mandates.
The author and the company have obtained the information contained in this article from sources they believe to be reliable but they have not independently verified the information contained herein and therefore its accuracy cannot be guaranteed. The author and the company make no guarantees, representations or warranties and accept no responsibility or liability as to the accuracy or completeness of the information contained in the article.
Glen Mifsud, Portfolio manager, BOV Asset Management Ltd.