A recovery without overheating
MONTHLY INVESTMENT BRIEF
We are therefore favoring a "barbell" positioning: cyclical stocks in Europe to benefit from the anticipated acceleration in growth and global "green" stocks, with a strong bias towards Europe
The keenly awaited US employment report for May again proved a disappointment, with non-farm payrolls increasing by 559,000 in May, thus falling short of the expected 675,000. What is more, the labour force participation rate fell slightly from 61.7% to 61.6%. Hence, the 0.3 percentage point drop in the unemployment rate to 5.8% therefore makes the labour market situation look somewhat better than it is.
Yet, while this data came in below consensus, the labour market growth seen in May is consistent with the Fed's projected timeline for raising rates by the December 2022 FOMC meeting (i.e., an average monthly rise in payrolls of around 500,000). In addition, the labour force participation rate will automatically increase in late summer/ early fall as schools, childcare facilities and educational institutions reopen. Similarly, with extra unemployment insurance benefits expiring in September, Americans will be more eager to re-enter the labour market, giving a boost to both the participation rate and non-farm payrolls.
U.S. Treasury yields fell following the report’s release, suggesting that slower-than-expected job growth is prompting investors to reassess the Fed's policy timeline. While disappointing, the jobs report does not warrant a change in the Fed's outlook in our view, including discussions about "tapering" this summer.
What strategy to adopt?
In fixed income, investors should keep duration low as inflation base effects will peak in a few months, likely leading to long rates moving up one last time before truly stabilizing. Only then (with US 10-year rates close to 2%) will it be time to reposition in US Treasuries and to buy growth stocks significantly.
In equities, it makes sense now to reconsider thematic equities, particularly "green" stocks, which have undergone a correction (albeit justified by extreme valuations), but whose outlook looks set to brighten up given the infrastructure stimulus plans. We are therefore once again favouring a "barbell" positioning:
- Cyclical stocks such as automotive and banks in Europe to benefit from the anticipated acceleration in growth
- Global "green" stocks, with a strong bias towards Europe
At a regional level, we see a 10% upside potential for Japan after its year-to-date underperformance. The reopening of the Japanese economy, an acceleration in the rollout of vaccinations and, in the longer term, a boom in green investments are all reasons to favour the “value" style in this country. In emerging markets, corporate earnings are trending higher: the consensus earnings growth forecast for 2021 for Asian equities is 36%; estimates for 2022 should be revised upward as vaccination progresses.
In terms of capitalization, smaller companies are best positioned at this point in the cycle to capture this positive momentum. Relatively speaking, they are historically cheap compared to large caps and have rarely offered such encouraging earnings prospects across all geographies.
As regards currencies, regardless of the timing of monetary policy normalization (in particular a possible tapering), the widening of deficits will further weaken the US dollar. Any strengthening of the dollar should be taken as opportunity to sell.
What are the risks?
In addition to risk of rate hikes already broadly covered in the media, we need to keep a close eye on the credit trend in China, a leading indicator of global growth/cycles. An overly sharp reversal could hurt global growth expectations in an environment where, let's not forget, equities are expensive and therefore likely to correct in the event of a significant change in the economic trend caused by changes in monetary or fiscal policy. We are far from it!
Stay invested in risky assets.