The first quarter of the year was dominated by rising bond yields and a value-led equity market rally. The two key drivers of this performance were the Democrat victory in Georgia at the start of the year, paving the way for massive further US fiscal stimulus, and the success of the vaccine rollout in the US and UK. It is now just over a year since equity markets bottomed and MSCI world has rallied 79% since then and is 18% above its pre-Covid highs and up 5% year to date (ytd). The 10-year US Treasury yield now stands at 1.75%, vs. 0.5% at the low in August and 0.9% at the start of the year.
The rise in bond yields has been closely correlated with significant outperformance for financials and value stocks. Value stocks are up 9.8% ytd compared with 0.3% for growth stocks. Higher commodity prices have also helped value stocks, with oil up 22% and copper up 13% ytd. The common theme driving all these moves has been rising optimism about the outlook for global growth.
Exhibit 1: Asset class and style returns
Source: Bloomberg Barclays, FTSE, MSCI, Refinitiv Datastream, J.P. Morgan Asset Management. DM Equities: MSCI World; REITs: FTSE NAREIT Global Real Estate Investment Trusts; Cmdty: Bloomberg Commodity Index; Global Agg: Barclays Global Aggregate; Growth: MSCI World Growth; Value: MSCI World Value; Small cap: MSCI World Small Cap. All indices are total return in US dollars. Past performance is not a reliable indicator of current and future results. Data as of 31 March 2021.
With over 37% of American and 58% of British adults now having received at least one dose of vaccine and the number of people being hospitalised with Covid much lower than at the start of the year, the continued rally in these equity markets makes sense, as investors look ahead to a hopefully sustainable reopening of their economies. Small cap stocks, which tend to be more domestically focused, have performed particularly well, with the Russell 2000 up 12% and the UK FTSE Small Cap index up 9% ytd.
Exhibit 2: World stock market returns
Source: FTSE, MSCI, Refinitiv Datastream, Standard & Poor’s, TOPIX, J.P. Morgan Asset Management. All indices are total return in local currency, except for MSCI Asia ex-Japan and MSCI EM, which are in US dollars. Past performance is not a reliable indicator of current and future results. Data as of 31 March 2021.
But even markets where the vaccine rollout has significantly lagged the UK and US have performed well. Eurozone equities are up 8% and Japanese equities are up 9%, despite these regions having vaccinated only about 11 and 1% of their populations, respectively. Both have been helped by a strong rebound in global goods demand, and financials have benefited from steeper yield curves. Despite low vaccination rates, Japan has seen very few Covid cases, but Europe is seeing cases increase, which could delay the domestic recovery.
Business surveys improved in March, with manufacturing expanding strongly in Europe, the US and UK. The US service sector continued to perform well, but the most notable improvement was in the UK service sector, with businesses noting improving consumer confidence and signs of pent-up demand. The European service sector was the clear laggard.
March also saw the passage of President Biden’s bumper stimulus package, worth 9% of US GDP. This has led to upgrades in consensus forecasts for US growth this year, with 7% growth now expected. Biden also doubled his vaccination goal from 100 million to 200 million in his first 100 days.
Some investors have worried that the size of the US stimulus, combined with pent-up savings, could lead to a pickup in inflation, potentially leading the Federal Reserve to tighten policy to an extent that could be damaging for equity markets. However, despite upgrading its growth forecasts for this year and expecting unemployment to decline to 4.5% by the end of this year and 3.5% by the end of 2023, the Fed does not believe inflation will be sustainably above target and still expects not to raise rates before 2024.
Exhibit 3: Fixed income sector returns
Source: Bloomberg Barclays, BofA/Merrill Lynch, J.P. Morgan Economic Research, Refinitiv Datastream, J.P. Morgan Asset Management. Global IL: Barclays Global Inflation-Linked; Euro Gov.: Barclays Euro Aggregate Government; US Treas: Barclays US Aggregate Government - Treasury; Global IG: Barclays Global Aggregate - Corporates; US HY: BofA/Merrill Lynch US HY Constrained; Euro HY: BofA/Merrill Lynch Euro Non-Financial HY Constrained; EM Debt: J.P. Morgan EMBIG. All indices are total return in local currency, except for EM and global indices, which are in US dollars. Past performance is not a reliable indicator of current and future results. Data as of 31 March 2021.
Emerging market equities have had a difficult few weeks after a strong start to the year, ending the quarter up 2%. Chinese equities sold off from mid-February; however, we believe that concerns around moderate policy tightening are overdone. Given the attractive long-term outlook for Asia, we are inclined to view the recent pullback as an opportunity for long-term investors, rather than a reason for significant concern. See our recent article Asia’s decade: Getting ahead of the growth opportunity.
Exhibit 4: Fixed income government bond returns
Source: Bloomberg Barclays, Refinitiv Datatsream, J.P. Morgan Asset Management. All indices are Bloomberg Barclays benchmark government indices. All indices are total return in local currency, except for global, which is in US dollars. Past performance is not a reliable indicator of current and future results. Data as of 31 March 2021.
Potentially of more concern are the increases in Covid infections in some other parts of emerging markets, such as Brazil and India. However, India may be less disrupted by another wave of infections given its young population, with only 7% of people aged over 65.
Overall, it was a bad quarter for government bonds/fixed income and a good quarter for most equity markets. The stocks that benefited most from Covid have been underperforming since November as the Covid losers have played catch up. We think this trade has further to run and that Treasury yields can still move higher by the end of the year. With equity markets having risen significantly over the last year, the gains from here are likely to be at a slower pace and with some bumps in the road. However, assuming the vaccines are effective at preventing hospitalisation against all variants of the virus, growth should be set to boom as soon as restrictions can be lifted. Against that backdrop, we remain positive on the outlook for equities relative to bonds.
Exhibit 5: Index returns for March 2021
Source: Bloomberg Barclays, MSCI, Refinitiv Datastream, J.P. Morgan Asset Management. Past performance is not a reliable indicator of current and future results. Data as of 31 March 2021.