- Global Markets Quarterly Update
- Second Quarter 2021
- Key Insights
- Global equity markets ended mostly higher in the quarter as coronavirus infection rates eased in most developed economies, with the notable exception of Japan.
- Rising inflationary pressures, due in part to lingering pandemic-related supply constraints, may have tempered investor enthusiasm.
- Long-term interest rates stayed contained or even fell as central bankers emphasized that the inflation spike would prove temporary.
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Stocks recorded strong gains in the second quarter as large-caps and growth shares reasserted their market leadership. The S&P 500 Index marked its fifth consecutive quarterly gain, the longest winning stretch since 2017. Within the index, the small real estate sector led the gains, returning 13.1% on a total return (including dividends) basis, followed closely by information technology, energy, and communication services shares. The small utilities sector was the sole segment to record a loss, falling 0.4%. The quarter was also notable for considerable volatility in so-called “meme” or “chatroom” stocks—smaller-cap, mainly consumer-oriented shares discussed heavily in social media platforms. Relatedly, Bitcoin and several other cryptocurrencies saw large price swings.
Longer-Term Yields Fall Back
Fixed income returns were positive in the quarter, helped by a decrease in longer-term U.S. Treasury yields. (Bond prices and yields move in opposite directions.) In mid-June, the yield on the benchmark 10-year Treasury note reached its lowest level since the start of March, pushed lower in part by overseas demand. Municipal bonds benefited from new federal support for state and local budgets, but mortgage-backed securities lagged amid fears that the Fed might soon reduce its purchases through a program designed to keep downward pressure on long-term interest rates.
Stocks got off to a strong start to the quarter, helped by a robust economic recovery driven by both fiscal stimulus and an accelerated coronavirus vaccine rollout. In early April, the Labor Department reported that employers added 916,000 jobs in March, well above expectations. The gain was later revised down to 785,000—and increases in April (278,000) and May (559,000) were smaller—but a shortage of available workers rather than a slowdown in labor demand appeared to be at work. The Labor Department’s tally of job openings reached its highest level in records dating back to 2000, and weekly jobless claims declined almost steadily throughout the quarter to pandemic-era lows. Gauges of both service and manufacturing activity also indicated healthy expansion.
The better labor market was reflected in consumer spending, which also got a boost from renewed stimulus payments. March retail sales grew by 9.8%, the most since May 2020, and measures of consumer sentiment reached their highest levels since the onset of the pandemic. The Commerce Department reported that gross domestic product (GDP) expanded at an annualized rate of 6.4% in the first quarter, and many economists were predicting the fastest full-year growth since 1984.
Inflation Makes Its Return, If Perhaps Only Temporarily
In a less welcome return to the past, inflation pressures also grew over the period. On May 12, the S&P 500 Index had its worst day of the quarter after the Labor Department reported that core (excluding food and energy) consumer prices jumped by 0.9% in April, the most in nearly four decades and roughly triple consensus estimates. Core prices rose another 0.7% the following month, also more than expected. The headline increase in consumer prices for the year ended in May hit 5%, the most since 2008.
For the most part, however, both fixed income and equity investors seemed reassured by repeated statements from Fed officials that inflationary pressures were likely “transitory” and due mostly to pandemic-related supply constraints. Indeed, some signs emerged late in the quarter that inflationary pressures might be peaking. Lumber prices tumbled from record highs as sawmills stepped up production, for example, and metals prices fell as China released stockpiles to cool the market.
Shares in Europe posted a fifth consecutive quarter of gains, as hopes for an economic recovery outweighed worries about an early tightening in monetary policy and uncertainty triggered by rising coronavirus infections caused by a new variant of the virus. Major indexes in Germany, France, Italy, and the UK also posted decent gains.
EU Delays Reopening as Infections Surge; EU Starts COVID Travel Certificate
UK Prime Minister Boris Johnson delayed a full reopening of society in England, which had been slated for June 21, for another month and said the vaccination campaign would be accelerated. The number of infections caused by the so-called delta variant of the novel coronavirus surged in the UK to the highest level since February, and there were signs that the variant was beginning to spread across Continental Europe, as well, particularly in Portugal. Meanwhile, France ended the nightly curfew that had been in place since October and began phasing out mask requirements in most public places, as did Denmark. Germany said it was planning to do so as well.
Sixteen European Union (EU) states began using the EU Digital COVID Certificate, which became available July 1. The EU mulled imposing restrictions on UK travelers but recommended that member states reopen travel to vaccinated U.S. citizens and urged the U.S. to ease a ban on European travelers.
ECB Sticks to Increased Bond-Buying
The European Central Bank (ECB) left policy unchanged and said that it would maintain emergency bond-buying at a higher pace for the next quarter, even though its updated forecasts called for higher near-term rates of inflation and economic growth. At a European Parliament committee hearing, President Christine Lagarde reiterated that it was important “not to withdraw support too early.” She also said that the outlook for the economy was “brightening” and that economic activity “should improve strongly” in the second half of the year. She asserted that rising inflation this year would begin declining at the start of 2022 as temporary factors fade out. ECB Chief Economist Philip Lane backed up her view that inflation would slow next year, opining that labor market slack meant it would be difficult to have strong wage inflation and a durable rise in prices.
Economic data showed a nascent recovery in the eurozone continued to pick up pace. A purchasing managers’ survey showed that an index of eurozone output rose to 59.1 in June, the fastest pace of growth in 15 years, as the economy continued to reopen and the services sector posted further strong expansion, according to IHS Markit. Official data showed inflation slowed to 1.9% in June from 2.0% in May, right on the central bank’s target.
BoE Holds Steady, Says Inflation Pickup Temporary
Bank of England (BoE) policymakers voted unanimously to keep the key interest rate at 0.1% and by eight to one to maintain the asset purchase program until the end of the year. The BoE said inflation could reach as high as 3% and economic growth would be strong, but the increases would be temporary.
UK inflation jumped again in May, accelerating above the BoE’s target to 2.1%, on higher prices for clothing, fuels, and meals in restaurants and bars.
Japanese equities lagged their developed market peers over the quarter, with the MSCI Japan Index generating a broadly flat return. The yen weakened to its lowest level since March 2020, finishing the quarter at JPY 111.11 against the U.S. dollar, while the yield on the 10-year Japanese government bond fell to 0.06%.
Slow Rollout of Coronavirus Vaccination Program Weighs on Sentiment
Japan’s relatively slow rollout of its coronavirus vaccination program weighed on investor sentiment. Authorities were slow to approve vaccines from abroad, and would only allow doctors to administer them. However, while the vaccine rollout lags the U.S., UK, and Europe, Japan is catching up quickly. It is producing vaccines domestically, which are now being administered not just by doctors but also by other trained medics.
Coronavirus states of emergency across Japan’s prefectures remained in place for much of the quarter amid concerns about rising infection rates. In late April, Prime Minister Yoshihide Suga announced the third state of emergency since the pandemic began in Tokyo and three other prefectures. At the end of the quarter, Tokyo remained under a quasi-emergency state, with authorities set to decide on a possible extension of restrictions ahead of the start of the Olympics on July 23. Prime Minister Suga hinted that the Olympics could be held without spectators; foreigners have already been banned from attending.
BoJ Announces New Lending Measure to Aid Climate Change Efforts
On the monetary policy front, investors gained reassurances that the Bank of Japan (BoJ) would maintain its accommodative stance: The central bank left key policy rate targets and guidance unchanged at its June monetary policy meeting, as widely expected. It extended the duration of the special coronavirus financing support program by six months to the end of March 2022, giving Japan’s vaccination drive more time to work. In a surprise move, the BoJ also announced a measure to support climate change mitigation: A new initiative will provide funds for bank lending to climate-friendly businesses. The climate change facility will start operating within the year, and the central bank will provide details at July’s meeting.
Sluggish Consumption Weighs on Economic Growth
In economic developments, Japan’s GDP shrunk by an annualized 3.9% in the first quarter, following double-digit growth over the previous two quarters. The decline was mainly due to a drop in private consumption as coronavirus containment measures curbed spending on clothing and dining out. Public consumption was also weak. Import growth outpaced exports, with growth in the latter slowing markedly as global chip shortages put a drag on overseas shipments. Looking ahead, BoJ Governor Haruhiko Kuroda said that, “the economy is likely to recover, with the impact [of COVID-19] waning gradually and supported by an increase in external demand, accommodative financial conditions, and the government’s economic measures.”
Industrial Production Contracts; Unemployment Rises to Highest Since December 2020
Separate economic data showed that industrial production contracted by more than expected, falling 5.9% month on month in May amid expectations of a 2.1% decline. The contraction was due primarily to carmakers and other manufacturers cutting back on production due to the global semiconductor chip shortage. Meanwhile, Japan’s unemployment rate rose to 3.0% in May, the highest level since December 2020. This compares with 2.8% in the prior month. Most sectors saw lower employment, including manufacturers, logistics, and finance.
Chinese stocks advanced in the second quarter. The benchmark Shanghai Composite Index and large-cap CSI 300 Index each posted solid gains. A sharp rise in domestic producer prices, a tougher-than-expected U.S. stance toward China under the Biden administration, and a regulatory crackdown on China’s e-commerce giants weighed on sentiment early in the quarter. Performance picked up in May, however, as weak economic data eased fears about tighter monetary policy and a stronger currency spurred foreign inflows. On the pandemic front, Chinese officials reportedly vaccinated more than 510 million people by the end of May and said that the country would reach herd immunity later this year.
Short-term interest rates were broadly stable as the People’s Bank of China (PBOC) kept policy unchanged. At its June policy meeting, the central bank said it would “keep the macro leverage ratio basically stable.” Growth in total social financing, China’s broadest measure of new credit, slowed to 11.0% at the end of May from a year ago versus 11.7% in April. Looking ahead, most analysts expect that credit growth in China will stabilize rather than continue to decline.
The yield on China’s 10-year sovereign bond fell 10 basis points to 3.10% following a net liquidity injection by the PBOC in June. The financial woes of China Huarong Asset Management Co. dominated credit news during the quarter. Huarong, the country’s largest bad-debt manager, which failed to report its annual financial results at the end of March, has emerged as a test case of Beijing’s willingness to bail out state-backed institutions amid a spate of corporate defaults.
Chinese Economy Continues to Normalize
Economic and social activity in China continued to normalize during the quarter, though growth in services and consumer-driven areas was slower than expected. The lack of new stimulus measures this year led some analysts to believe that cyclical momentum may be close to peaking.
Economic data readings revealed strong external demand but softer domestic demand. Residential construction and infrastructure investment both slowed, but consumption was the big disappointment as retail sales remained sluggish, with two-year average growth of 4.5% in May (analysts focus on two-year average growth rates to strip out base effects from last year’s coronavirus disruption). A COVID-19 outbreak in the southern coastal province of Guangdong, which accounts for 10% of national sales, was likely a contributing factor. However, labor market signals were more positive, with urban unemployment nearing pre-pandemic levels.
In other economic readings, China’s producer price index in May rose 9.0% year over year compared with 6.8% in April due to higher commodity prices, raising worries that price increases in China would add to global inflationary pressures. However, the consumer price index (CPI) rose a below-expected 1.3% in May. Analysts see little risk of a rate hike in China since CPI inflation remains well below the central bank’s 3.0% target. Moreover, analysts believe that a rate hike would run counter to the government’s other policy goals, such as curbing currency gains and spurring domestic consumption.
Questions About Fiscal and Political Outlook Weigh on Colombian Stocks
Colombian stocks, as measured by MSCI, returned -2.87% versus 5.12% for the MSCI Emerging Markets Index. Colombian assets were pressured by uncertainty about the country’s fiscal and political outlook.
In mid-April, Colombian President Duque introduced a tax reform proposal that proved to be unpopular and catalyzed widespread protests that eventually turned violent. The bill, intended to address the government’s challenging fiscal situation, would have increased the collection of value-added taxes (VAT) while gradually increasing personal income tax rates, including on the lower and middle class.
Colombian markets were hurt by Duque’s decision a few weeks later to scrap the tax reform proposal and by the resignation of the country’s finance and deputy finance ministers. Shortly thereafter, S&P Global Ratings lowered the country’s sovereign credit rating one notch to BB+ with a stable outlook, just one month after reiterating its BBB- rating with a negative outlook. This downgrade into the below investment-grade universe reflected S&P’s belief that the withdrawal of the tax reform bill would lead to slower fiscal consolidation and greater deterioration in public finances. While T. Rowe Price emerging markets sovereign analyst Aaron Gifford was not surprised by the downgrade decision, it took place sooner than he expected.
Despite the withdrawal of the tax reform proposal, activists expanded their list of demands. Protests continued for several more weeks, costing the economy more than 1% of its GDP, according to the government. In mid-June, the National Strike Committee called for a temporary halt to demonstrations following the end of unsuccessful negotiations with the Duque administration. Rather than abandoning its efforts to force change, however, the Committee launched a campaign to gain broader support by meeting with people in key economic sectors in an attempt to build a united front. Its goal is to stage a march to the capital on July 20, when Congress is back in session and the Duque government plans to make another attempt at tax reform.
Peruvian Stocks Drop Amid Political Uncertainty
Stocks in Peru, as measured by MSCI, returned -8.78% in the second quarter and underperformed the MSCI Emerging Markets Index.
Peruvian assets were particularly hurt by political developments. The country held its first round of presidential elections on April 11. Socialist Pedro Castillo squarely beat conservative Keiko Fujimori, but not by enough to avoid a second-round runoff on June 6. Despite a significant narrowing of his lead, Castillo still garnered 50.1% of the final votes versus 49.9% for Fujimori.
As of the end of June, however, the voting results still had not yet been made official. Fujimori has made claims of voting fraud, and a ruling by the National Jury of Elections has been delayed by the stepping down and replacement of a judge on a four-person panel reviewing various ballots to determine their authenticity.
Meanwhile, supporters of each candidate have been staging rallies in public. The financial markets have been bracing for a victory for Castillo, whose political platform has included creating a new constitution, nationalizing key industries, and significantly increasing the state’s influence on the economy. On the positive side, Castillo has recently been moderating his positions, but Gifford notes that plenty of uncertainty still exists. The new president will take office on July 28.
Major Index Returns
Total returns unless noted
Past performance is not a reliable indicator of future performance.
Note: Returns are for the periods ended June 30, 2021. The returns include dividends and interest income based on data supplied by third‑party provider RIMES and compiled by T. Rowe Price, except for the Nasdaq Composite Index, whose return is principal only.
Sources: Standard & Poor’s, LSE Group, Bloomberg Barclays, MSCI, Credit Suisse, Dow Jones, and J.P. Morgan (see Additional Disclosures).
While the global economic recovery was faster and stronger in the first half of 2021 than markets seemed to expect at the start of the year, there also are potential risks to growth that we will be monitoring in the months ahead. These include:
- The coronavirus. While vaccine campaigns have gathered speed in some developed countries, progress remains slower elsewhere. Meanwhile, new variants remain a potential threat.
- U.S. fiscal policy. Although the Biden administration is seeking to raise the U.S. corporate tax rate, any increase is likely to be moderate and neutral for U.S. equity markets. However, proposed increases in capital gains and dividend taxes, if enacted, would be negative for after-tax returns on most asset classes.
- Valuations. Price/earnings multiples in some sectors and stocks imply demanding earnings expectations. Even relatively strong second-half results might fail to meet those expectations, generating market volatility.
- Political instability. Latin America, Eastern Europe, and the Middle East all contain potential flash points that could disrupt the global recovery.
That said, a transformed global economic landscape is generating potential opportunities as well as risks. Disruption creates both winners and losers, giving active portfolio managers greater scope to seek excess returns and alpha.
Strong fundamental research skills, backed by adequate global resources, are vital assets in that search. That means having analysts around the world who can meet with management and communicate on strategy and capital structure.
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