2021: So far, so good, but what now?

 July 2021

It has been a good first half of the year for risk assets, driven by reopening, vaccinations and stimulus.

Economic growth and company earnings growth have shown supra-normal recoveries from the depths of lockdown. The big question as we enter the second half of the year is, can this continue given the spread of the delta variant?

The authorities seem comfortable with the pick-up in inflation and are determined to maintain support for worldwide economies. This month we look at various aspects of current market conditions.

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More upside to come?

US earnings season is with us again and there is the expectation that earnings growth will be 64% for the second quarter which, if materialised, would be the second best year-on-year quarterly gain in the last 25 years.

This expectation has led to markets pricing in this “supernormal” growth which raises the risk that any undershoot would challenge those current valuations in equity markets. However; as we all emerge from a global pandemic and with lockdown restrictions beginning to be lifted there is a very supportive environment for companies to achieve higher earnings.

Investors will also be keeping an eye on company commentary on raising prices and, if so, what is the forecast impact of this on future earnings. At present, Q3 earnings are expected to be strong, but we may see a shift in this following any earnings revisions made over the next few weeks.

Yields paused

In February we saw inflationary concerns come to the fore as the improvement in vaccination distribution increased the market expectation for future growth and inflation. This lead to investors selling out of bonds, which in turn increased the yield.


Table 1: US 10yr yield (Source: MarketWatch)

We have since seen yields fall with the US 10 yr yield falling to a three month low. There is not an obvious single causal factor for this, but instead a combination of several factors:

1. Slowing global growth

Recent data from China showed that the bellwether of the COVID-19 recovery is beginning to slow, with GDP expected growth rate forecast to fall to 8% in Q2 vs the 18% in Q1.

A fall is unsurprising, given the base effect of starting from an abnormally high number, but the timing of the fall was a surprise to the market. This also coincided with the People’s Bank of China reducing its reserve requirement, which was introduced to increase the liquidity to small businesses which have been struggling to return to pre-pandemic activity levels, and is perhaps provides an insight into the challenges other countries will face.

This slowdown in growth (particularly in China) should prove to be disinflationary over the short term as the demand for commodities and capital goods reduces. These two factors (slowing growth and lower inflationary pressures) are tailwinds to bond prices.

2. Central Bank policy and rhetoric

Central Banks at the moment are stuck between a rock and a hard place.

On one side a signalling of a reduction in stimulus is greeted by fears that the market will no longer be underpinned by huge amounts of liquidity. Conversely continued stimulus in its current form presents the issue of how economies will wean themselves of this debt induced growth.

We have recently seen members of the Federal Reserve contemplating the reduction of its Asset Purchase Program, which the market viewed as a potential reduction in liquidity, and when this occurs you tend to see investors move from “risk” assets such as equities into “risk off” assets like government bonds.

3. Attractive valuations

Bond investors have had a challenging time recently dealing with low yields and the prospects of higher inflation. Yields increasing gave the opportunity for investors to enter the market at a more attractive valuation, this was highlighted in the recent US Government bond auction which saw strong demand across the curve.

We have also seen large institutional investors, like pension funds, reduce their allocation to equities (capitalising some of the gains they have made) and move into bonds. Bonds have a notable benefit for pension funds as their fixed coupon payment can be used to help fund retiree benefit obligations.


The overall environment still looks supportive for risk assets but we are mindful that the tailwinds could be challenged as the year progresses and we pass the peak pace of recovery. There are still risks that can cause market volatility so we think that a diversified approach to portfolio construction is appropriate.

If you would like to discuss anything we have raised here then feel free to get in touch with your TPO adviser.

Please note, the value of your investments and the income from them can go down as well as up.

If you would like to discuss your investment portfolio then please contact your TPO adviser or arrange a free consultation.

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Note: This Market update is for general information only, does not constitute individual advice and should not be used to inform financial decisions.

Investment returns are not guaranteed, and you may get back less than originally invested; past performance is not a guide to future returns.