Investment Update June 2021

The markets are taking a moment to catch their breath

In May, developed market equities stagnated (in euros). They fell slightly by -0.10% in euros due to the depreciation of the USD during the period. Overall, the European markets were the strongest performers of the developed markets.

On the fixed income side, the markets were rather undecided. The US 10-year bond yield fluctuated around 1.65% to finish the month at 1.60%, while the German bond yield on the same maturity remained between -0.20% and -0.10%.

At present, the markets are experimenting with a phase of hesitation due to the debate surrounding inflation and the support of central banks.

The latest US consumer price index reached 4.2% in April on an annual basis, its highest level in 13 years. This has raised concerns amongst market analysts of an aggressive rise in bond yields, threatening to make the equity markets relatively less attractive.

There are many indications that the observed inflation would be more temporary than sustainable. Let us not forget: a year ago, inflation had fallen due to the pandemic.

In addition, it is the most cyclical components of the inflation basket that push the index upwards. When we look more closely, core inflation (excluding food and energy) is 3%, a level that is already less worrying.

On the issue of inflation, the US Federal Reserve is in the less worried camp. Indeed, according to many economists, the deflationary factors that have persisted for several decades are still in effect: the globalisation of trade, digitisation, the decline in the unionisation rate and the bargaining power of employees are all factors that reduce inflationary costs and pressures.

It is conceivable that inflation will be at a slightly higher level than we have seen in the last decade, but it should remain controlled. The recovery is happening very rapidly, and households have a historically high level of savings. A catch-up effect on demand could push prices higher.

The issue of rates is tied to the issue of inflation. If inflationary pressures are sustained, the central banks may be forced to raise key rates or limit asset purchase programmes.

In short, there is a lack of evidence to address the issue of uncontrolled inflation. This is why we favour the scenario where inflation remains at a higher level than in previous years (>2%) for several quarters. Indeed, the bottlenecks in the supply chain suggest that the issue of inflation will still be on the table. Furthermore, this context leads us to give further consideration to the management of duration risk in portfolio construction by questioning the added value of this risk.

For the time being, real bond yields remain mostly negative in developed countries, and we continue to favour equities over bonds. From a sector perspective, we continue to favour sectors that promise strong long-term growth while adding a degree of cyclicality, a combination offered for the past several months by Industrials and Materials.

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This document was produced by the Private Banking Unit and BCEE Asset Management.  The drafting of this document was completed on 12 May 2021 at 2:00 pm.

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