Market updates from June
The main story over the second quarter concerned the US Federal Reserve (‘Fed’), which in signalling the tapering of treasury and mortgage-backed security purchases sooner than expected heralded the beginning of the end of emergency policy. Their rationale was based on a greater conviction in the economic recovery and upside risks for inflation, although the counterintuitive treasury rally that followed suggests that bond investors at least aren't so convinced. The other story was of course the coronavirus, more specifically the increasing spread of the more infectious Delta variant, even in places with a strong vaccination programme such as the UK and Israel. The concern here is that yet another outbreak reverses the economic reopening that's currently underway, although the ongoing credit, equity and commodities rallies perhaps suggests otherwise.
With equity and credit markets continuing to make broad progress, the investment profiles made encouraging upward moves over the quarter. However, we’ve seen something of a change in leadership in equity markets, with re-opening recovery exposures taking a breather and quality growth re-asserting itself. US Equities was the strongest market, with Japan, Asian and Emerging Markets trailing. Although investors sold the more cyclical areas of equity markets, this wasn’t the case with bonds, where both sovereign and corporate bonds rallied across regions and ratings, helped by a flat USD.
As we’ve moved into the third quarter, we’ve seen risk assets wobble a little as concerns over the spread of the Delta variant have escalated, putting growth expectations under pressure. This has seen defensive assets move to the fore with US Treasury yields declining further and recovery trades hit hardest. Our initial assessment is that whilst we may have a period of unsettled markets, this is typical market volatility on the back of some strong upward moves and investor positioning becoming a bit one-sided.
Although emergency policy will gradually be tapered in the coming months, central banks and governments remain highly accommodative, and we suspect inflation will be transitory enough for this to continue. Although the spread of the Delta variant does threaten the economic reopening, vaccination programmes appear to protect the most vulnerable, and we suspect public acceptance of the disease becoming endemic will enable this to continue. We are currently more concerned about the technical backdrop of markets, specifically breadth, positioning and valuations, following months of increasingly bullish sentiment and given waning positive momentum in the macroeconomic data. These considerations make us more cautious in the short term, although a positive fundamental and technical backdrop for risk assets persists over a longer horizon.
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