In the past two weeks we have seen rising concerns of a potential rotation away from sectors in the stock market which performed well in 2020, especially technology and growth stocks. Driving this are worries that inflation could be about to increase, which might negatively impact certain asset prices.
The fears of higher inflation impacting stocks is not irrational. A change in expectations for monetary policy, namely a higher probability that interest rates will increase due to higher inflation (historically higher inflation is met with interest rate rises), impacts market valuations. As interest rates rise, discount rates rise too, and this lowers the value of future cash flows of companies, thus lowering their valuations. If interest rates really were likely to rise soon, this would be legitimate cause to evaluate equity market exposures.
Federal Reserve Chairman Jerome Powell, however, allayed these concerns on February 23rd, saying that significant increases in spending from opening-up the economy may cause an inflation spike later this year, but it is “unlikely to generate sustained inflation” since there is significant spare capacity in the economy (high unemployment). In other words, he is telling the market to expect some inflation, but it will be “transitory” and interest rates will not rise. He further noted that we have seen 25 years of deflationary forces in the global economy (new technologies, globalisation, ageing populations) and this is unlikely to reverse anytime soon. We agree.
Strong domestic consumption data in China / Things are looking rosier in Europe
Consumption at major retailers and restaurants in China between the 11th and 17th of February (Chinese New Year holiday) hit 821 billion yuan ($127 billion) according to China’s Commerce Ministry. That is a +29% jump from last year’s pandemic-disrupted holiday, and (more impressively) a +4.9% increase against the same period in 2019. Part of this strong performance is likely pent-up demand from 2020 as well as cash usually spent on travel being redirected to purchases of food, entertainment, gifts, and other sectors hit by COVID. We may see a similar pattern in other economies as they open-up through 2021.
In Europe, economic data finally seems to be trending in the right direction. The IHS Markit Composite PMI for Germany rose to 51.3 in February while the Germany Manufacturing PMI jumped to 60.6, well above market forecasts of 56.5 (remember that any number above 50 indicates expansion). The IFO Business Climate Indicator for Germany rose to 92.4 in February, above market expectations for 90.5, as assessments of the current business situation turned more positive. The Manufacturing Index for the Eurozone jumped to its highest level since November 2018 and the Business Climate Index rose across all major sectors. Even the tourism industry in Europe is turning cautiously optimistic, as the possibility of a return to something like normality comes into view.
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