The second quarter of 2021 started with continued rotation towards ‘value’ or investments that have been labelled as ‘Covid losers’, but the trend suffered a sharp reversal in June as investors gravitated back towards ‘Covid winners’ and Technology stocks. In part this was driven by renewed Covid concerns and the emergence of a highly transmissible Delta variant.
There is little room for disappointment, in terms of the equity index averages, as headline valuations remain elevated relative to history. The valuation premium paid for good companies and attractive sectors has never been higher, while the relative valuation of deep value and unloved sectors have rarely been at such a wide valuation discount to the
wider market. The wild rotations we are seeing are probably a side effect of this dichotomy, as investors are ‘caught between the devil and the deep blue sea’ (neither option feels comfortable) and are actively trading to avoid being caught on the wrong side of these violent rotations. From our perspective we continue to tread the ‘Middle Way’ as proposed by Buddha and try to find a suitable balance that avoids the extremes of the valuation scale and is well diversified across regions and sectors.
It was another strong quarter for US equity markets as broad-based equity gains pushed the S&P500 towards new highs. There remain much dialogue and uncertainty around the outlook for inflation and the future path of interest rates. Factoring in base effects from the Covid pandemic it is not surprising that we have seen a steep rise in the level and trajectory of inflation, but it remains hotly debated whether we are in a new regime of structurally higher inflation. In the absence of further stimulus/deficit spending it remains likely that inflation at current levels is not sustainable and the recent spike in some elements of the inflation basket will prove temporary.
Eurozone equities had a good quarter, with the STOXX Europe 600 +5.41%, as a strong improvement in corporate earnings trend combined with positive developments and acceleration in vaccine roll-out created a positive environment for risk assets. The European Commission continued with recovery plans and signed a €800bn Next Generation fund.
In the UK, performance was more mixed despite relatively good headline performance numbers. The early part of the quarter was characterised by strong outperformance from economically sensitive stocks and small-cap holdings, but this trend reversed in June as investors sought protection in large cap stocks and more defensive names – a trend
amplified by weakness in sterling versus the US dollar exchange rate. This change in investor positioning has been attributed to renewed Covid concerns as the government pushed back on easing some restrictions and delayed the anticipated timeline for “Freedom Day”.
It was generally a robust quarter for EM equities, with the MSCI EM Index +4.42% despite several headwinds, including a stronger US dollar and renewed questions around the trajectory of inflation/interest rates and the prospects for tightening monetary policy conditions in the developed world.
Within fixed income, US treasury yields on the 10-year maturity retraced some of the Q1 movement higher and settled below the 1.5% level. This movement occurred despite continued improvement in the economic backdrop and annualised inflation levels well above the target rate. The recent narrative has been shifting towards the view that much of this inflation is transitory and that peaking growth rates could continue to exert downward
pressure on interest rates in the medium and longer-term.The S&P GSCI Commodity Index achieved a very strong return in the second quarter. This was largely the result of big gains from the Energy complex (Brent oil +18.24% and WTI oil +24.19%) and continued optimism towards a global recovery, which helped many of the other index constituents deliver quarterly gains. There were also positive moves within precious metals, as gold +3.65% and silver +7% finished the quarter higher.