Investment Strategies For A Global Recovery

International | Mar 29 2021

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As the global economy swings from the recovery phase to expansion there are important policy and market implications for investors

-2021 is set to be the strongest year for global growth since 2007
-Australian sector and stock preferences
-Are we set for a commodities super cycle?

By Mark Woodruff

Commentary in US financial markets has transitioned from recovery to expansion. The recovery has been enabled by the size of the monetary and fiscal stimulus to date and the relative lack of structural damage. Additionally, unemployment has reversed quickly, bankruptcies have been contained and banks have excess capital in many cases. Sentiment is also being assisted by the commitment of the US Federal Reserve to not raise rates until inflation is above 2%.

As usual financial markets are forward looking and towards the end of 2021 there is additional upside risk from the Biden Administration's plans for a reported US$3 trillion infrastructure and education package. In addition, corporate profit growth that is not expected to peak until 2022 and a successful vaccine rollout builds on the momentum.

However, the shift toward expansion investors now has investors grappling with inflation expectations and speculation around the timing of any tightening of monetary policy, which has resulted in recent volatility on bond markets. 

On equity markets the style pendulum swings between growth and value while discussions around a commodity super cycle gather pace. Differentials in recovery phases and interest rates across geographies are also impacting currency movements which play a part in equity allocation decisions between developed and emerging markets.

While the global economy is back to pre-covid-19 levels, the recovery has been uneven. Asia is leading the way and China’s industrial activity has recorded strong growth so far in 2021, but a sustained recovery in Europe remains elusive.

With all these variables and more it is timely for investors to review how portfolio managers worldwide are adjusting their exposures. However, let’s first review the macroeconomic outlook.

Global growth and interest rates

Strategists at ANZ Bank forecast 2021 is set to be the strongest year for global growth since 2007. Those economies within the bank’s coverage which didn’t return to pre-covid-19 levels of activity last year are considered likely to do so this year.

Because consumption is on such a strong footing, ANZ believes growth is more sustainable than the post-GFC growth spurts proved to be. Household debt servicing in a range of economies including the US, Australia and New Zealand is at the most advantageous levels in decades.

Rather than bankruptcies rising sharply during the crisis, in many economies they have actually fallen. While unemployment rose sharply in 2020, it has declined unusually quickly in many economies, with under-employment also declining in some cases. As a result, banks have generally not finished this crisis with an overhang of non-performing loans which might normally crimp lending appetite and encourage caution.

The bank notes the inflation dynamic out of the covid-19 crisis is quite different to that emerging from the GFC twelve years ago. This is already being indicated by the US bond market which is pricing five year inflation to average 2.3%, which is ahead of the Fed’s stated 2% hurdle.

The money market strategists at the ANZ feel inflation seems to be something of a given. Base effects, supply chain constraints, shipping tightness, and strong commodity prices suggest most economies will report meaningfully higher inflation this year. However, for inflationary pressures to persist beyond calendar 2021 (the bank’s expectation), labour markets will need to continue to tighten at a meaningful pace.

The Fed’s stated intention is to be late in tightening interest rates. If the Fed is later in tightening than normal, then presumably once it starts to hike, it will need to move more quickly than normal, outlines ANZ. Other central banks, most notably the RBA, have adopted a similar ‘later’ stance.

According to Citi strategists the global macro environment is reflationary and they have revised global growth forecasts higher and suggest risk assists should be bought on weakness. They have a bias toward equities and commodities over credit and government bonds.

The preference for equities overall is due to the combination of strong global economic data momentum, loose monetary policy and high cash balances. This is a judgement call that rising rates will not undermine equities at a time of strong growth momentum. 

Also, while QE is ongoing, dips in equities are shallow and should generally be bought. This next dips could be linked to tax selling in April or broader tax hikes in the US.

Citi also invokes history by noting the 2013 tapering sell-off did not lead to major pull-backs in developed market equity risk. And that was a time when the Fed was more hawkish and growth momentum was weaker than it is in early 2021. 

Within equities, the investment bank leans toward the US (materially higher fiscal stimulus) and Japan over Europe and emerging markets (EM).

Taking the counter view on growth, Oxford Economics feels the level of global GDP is unlikely to return to its pre-crisis path and therefore the path for stock market earnings will be lower. Also, yields are likely to remain low in the medium term despite mounting public debt levels. Finally, disinflationary forces are expected to remain strong in the recovery, and inflation will continue to behave in a weakly pro-cyclical manner.

The leader in global forecasting argues that while inflation has the potential to ruin 2021 for investors in both advanced economies (AE) and EMs, they see no signs of lasting pressures that might turn a temporary spike into a lasting overshoot. Meanwhile, current concerns may yet give way to further risks of deflation as policy stimulus is withdrawn.

The US economy and stockmarket

Morgan Stanley continues to believe the consequence of the extraordinary actions taken by major governments and central banks to alleviate the impact of lockdowns and social distancing will see the return of inflation and ultimately a gradual increase in long term interest rates. 

However, the investment bank now also expects that this surge in fiscal and monetary stimulus will bring forward growth and possibly shorten the current economic cycle, though it is important to note the current economic cycle still has years ahead. 

The bank has confidence in higher equity markets over the next twleve months, supported by the Democrats' plans for an infrastructure and education package, upside from a successful vaccine rollout and corporate profit growth.

Morgan Stanley remains overweight equities, credit and commodities and underweight in bonds and cash and continues to rotate out of relatively over-valued early-cycle assets and move towards more attractive mid-cycle investments.

In the US, mid-cycle investments are regarded as automotive manufacturing, retailing, consumer durables, consumer apparel and capital goods. 

Morgan Stanley has adopted an even-weight exposure to the US to reflect the rotation away from relatively more expensive growth/technology stocks, which represent the largest weights in the S&P500 Index

Despite underwhelming February inflation numbers, Citi doesn’t doubt that near term inflationary pressures are prevalent. Input costs for manufacturers have risen with commodity prices on strong demand and supply chain disruptions. The recent Fed Beige Book and National Federation of Independent Business (NFIB) surveys have signaled that businesses are struggling to hire dis-incentivised workers, which suggests stronger wage growth on the horizon.

ANZ agrees and expects both core and headline US inflation are set to pick up notably in coming months. This is due to a number of factors including a sizeable jump in food and energy prices and fiscal stimulus bolstering household spending power. Additionally, there will be some pass-through of higher input prices as manufacturers face supply bottlenecks amid stronger-than-expected demand for durable goods. 

Importantly, the analysts don't see any of these factors being persistent and expects these inflationary pressures to slowly dissipate over time. The expectation is for headline inflation to average 2.5% year-on-year in 2021 and ease to 2% in 2022. Inflation is unlikely to be a problem, at least in a sustained way until maximum employment is reached, which is not anticipated prior to the end of 2022.

Meanwhile ANZ has doubled its US GDP forecast for 2021 to 6% from the 3% estimate of late last year, which would be the fastest pace of annual growth since 1984. It’s anticipated the level of GDP will surpass its pre-pandemic high of quarter four 2020 in quarter two of 2021.

The outlook has improved since the start of the year when the Democrats secured Senate seats in Georgia, to secure control of the Upper House, making passage of certain bills more likely. The other positive has been the faster-than-expected distribution of vaccines.

However, not all assessments for US equity markets are positive. According to Oxford Economics, valuations are so lofty the analysts find it hard to be positive in either the short term or the next five years.

Investors are told to expect long-term rotations in favour of non-technology and non-US assets as markets could be on the verge of a multi-year trend of US equity underperformance and a bear market in the US dollar. They believe the bull’s argument for the US based on low real rates is testing its limits, particularly given valuation gaps.

Oxford Economics sees the reversal of two trends that could potentially start a convergence of the extreme valuation gap between the US and the rest of the world.

Firstly share buybacks (via negative equity dilution) have boosted US EPS growth relative to other markets over the past decade. However, the amount of shares repurchased has collapsed this year as the boost from tax reform has faded. Buybacks will likely remain muted over the next few years as corporate sector looks to rebuild cash buffers and repair balance sheets. There’s also a risk the Democrats could introduce legislation that limits the attractiveness of buying back shares.

Additionally, until now, rising technology industry concentration has provided US companies with greater pricing power. This could now be changing with the growing emphasis on antitrust enforcement in the US, particularly in the context of a Democrat-led government. 

When Citi analyses metrics pertaining to the S&P500, it seems quite obvious US stocks are trading fairly expensively. While not as outlandish as during the tech boom in 1999-2000, there are parts of the growth space that seem excessive at 10-30 times revenues, despite their attractive long-term futures.

The investment bank calculates that 54% of the S&P500’s value is now attributable to profit growth. The large proportion in and of itself is not extreme given an expected strong recovery, boosted by stimulus dollars and large savings. However, after an 80% rebound in equity prices since the lows of March 2020, it is fair to suggest that much of the good news is getting priced in and the upside potential becomes more limited from here.

Citi believes fiscal stimulus supports its longstanding view of opportunities in the travel, leisure and hospitality sectors, especially as vaccines allow people to get out more over the next few months.

From a style perspective, growth stocks could get a bid later this year and the small caps’ joy ride is likely nearing its end, particularly given buoyant investor sentiment that often mean forthcoming risk-off consequences.

In concluding comments, Citi's strategists worry that too many investors are excited about GDP growth north of 6%, without fully understanding what is being discounted in share prices, especially when sentiment analysis shows euphoric mindsets.

The macro strategy team at Macquarie sees the current rise in yields as a “light” version of the 2013 “taper tantrum”. In 2013, real yields increased 180 basis points (bps), compared to only 45bps so far this year. The team notes the increase in real yields had little impact on the S&P500 in 2013, with the index rising around 30%.So rather than being a headwind, increasing yields are often accompanied by a rise in equities.

However, falling valuations are considered a greater risk in 2021 than in 2013 as there are now higher-starting PEs, and there is a negative correlation between real yields and valuations. The rise in real yields is likely to continue to drive the rotation to stocks that benefit from higher yields such as value and financials.

The Australian Economy

ANZ Bank expects GDP in Australia to rise 4.2% through 2021 and 2.7% through 2022. With population growth much lower than usual, these growth rates are much stronger than trend. On a per capital basis the forecast is for GDP growth at 3.6% in 2021 and 1.8% in 2022, well above the average of 0.9% recorded in the five years to 2019.

Over the next year or so the bank sees a range of strong tailwinds that will drive economic growth. Monetary policy is set to remain extremely accommodative, with the RBA planning to keep the cash rate at 0.1% until at least 2024. Fiscal policy will be winding back, but measures put in place to support housing and investment will support growth in 2021 and early 2022. 

In addition, global growth should be particularly supportive, with massive fiscal stimulus in the US driving strong growth there and supporting a robust global recovery. This should also help underpin elevated commodity prices.

Consumer spending has bounced back well as restrictions lift and sentiment improves, and households have a large buffer of savings. Strongly rising house prices will also support consumers this year, according to the strategists at ANZ.

Housing prices are being supported by low mortgage rates and the prospect of this continuing for an extended period. Meanwhile, housing construction is rebounding sharply supported by the federal HomeBuilder scheme, other government support and low interest rates. Finally, business investment has already turned higher, and the bank expects a solid recovery through 2021.

Given the bank’s view on the wages outlook, inflation is not expected to lift above 2% until 2023 at the earliest. Australia needs the unemployment rate to be in the 3’s for an extended period for wages growth to lift enough to push actual inflation sustainably into the 2 to 3% range that the RBA is monitoring.

Australian Sharemarket

Despite having successfully navigated the pandemic so far, the Australian share market continues to lag global peers particularly the US, due to a lack of exposure to growth. By mid-March the Australian market had yet to fully recover to the February 2020 peak and remained -4.4% below that peak, compared with global markets which in aggregate were 17.5% higher.

This underperformance is driven by the structural differences between the US and Australian markets. Australia has an absence of growth stocks to the same degree as the US, with the S&P500 being comprised of 26% of technology stocks and 13% of health care stocks. Instead, our market capitalisation is largely made up of resources and banks.

Recent actions taken by the RBA to buy government bonds to bring down long-term interest rates are a strong indication monetary policy will remain accommodative. For this reason T. Rowe Price has doubts around the ability of interest rates to derail the recovery.

The global investment management firm has tilted portfolio positioning towards more domestic exposures to reflect a stronger economic performance of the Australian economy. They also expect growth stocks to continue to do well should there be a contained yield environment. To fund these portfolio changes profit was taken on defensive growth names and exposure to offshore earners was somewhat reduced.

Australian sector and stock preferences

At a sector level in Australia, Citi is positive on resources, building materials and retail. In resources, the analysts expect elevated commodity prices, strong cash flow, and high dividends to continue. The fundamentals in Chinese steel production are also expected to remain supportive while the supply of iron ore continues to be constrained.

The majority of resource sector outperformance has been driven by earnings and Citi believes there is potential for further outperformance. As a result the investment bank remains optimistic about fundamentals supporting BHP Group ((BHP)), RIO Tinto ((RIO)) and Fortescue Metals Group ((FMG)).

Whilst the banks have always paid a steady portion of the dividends in the market, the most significant growth has come from resources, particularly the three above-mentioned stocks. Dividends in the sector have grown from a modest $8.4bn in FY16 to a staggering $57bn in FY21. They comprised 56% of FY21 total market dividends (up from 14% in FY16) and Citi's resource analysts expect this level of dividend to be sustained into FY22.

The building materials and retailing (both staples and discretionary) sectors have shown solid earnings growth relative to FY20 levels. Both sectors have also underperformed the market of late, despite upgrades to earnings, points out Citi.

A resurgent housing cycle should generate building and renovation activity. Positive impacts from greater housing churn activity should spill over to retailers such as Harvey Norman ((HVN)), Nick Scali ((NCK)) and Bunnings, which is owned by Wesfarmers ((WES)). Structural change in household spending should mean permanently higher levels of retail spending.

Wilsons believes the combination of rising long-term rates, rising inflation expectations and a steepening yield curve suggests the market will seek out cyclicals and other reflation beneficiaries.

Wilsons screens for equities with strong value, momentum metrics and a bias towards conventional inflation beneficiaries. The resulting shortlist includes Adairs ((ADH)), Champion Iron ((CIA)), Nick Scali, SkyCity Entertainment ((SKC)), Super Retail Group ((SUL)), Pact Group ((PGH)) and Ooh!Media ((OML)). 

Wilsons also predicts sizeable returns for many services-based businesses as the ‘service reopening’ thematic will likely gather momentum across the second half of 2021 and into 2022 as global lockdown restrictions are eased. Consumer behaviour change will simply be the directing of spend from the household to a local holiday within Australia until overseas travel becomes viable in early 2022.

The private wealth management firm likes Sydney Airport ((SYD)) in order to gain exposure to services-based spending as recent February traffic numbers showed the second-best month for domestic traffic volumes since covid-19 hit. Whilst profitability is heavily exposed to international travel, a lower valuation versus pre-covid-19 suggests a much larger ‘margin of safety’, which should better protect investors if the reopening was delayed. Additionally, Aristocrat Leisure ((ALL)) is favoured as it will benefit from the economic reopening via traditional land-based gaming machine sales.

On the flipside, goods consumption growth is expected to soften and potentially will go negative, as services spending accelerates. Preferred goods exposures are to Reliance Worldwide ((RWC)) and Super Retail Group.  Both companies are likely to see another round of earnings upgrades driven by buoyant activity levels relative to expectations, which are not considered to be captured in the share price.

Wilsons have elected not to play travel companies like Flight Centre ((FLT)), Corporate Travel Management ((CTD)), Qantas ((QAN)) and Webjet ((WEB)) as valuations look to have more than captured the potential improvement in activity. Also, there remains a high degree of uncertainty as to when international travel can resume.

Other service-based companies Atlas Arteria ((ALX)) and SkyCity Entertainment also interest Wilsons on the “service reopening” thematic.  Both have depressed earnings and valuations in-line or below pre-covid levels.

In-line with the move towards more attractive mid-cycle investments for US equities, Morgan Stanley believes housing-linked sectors should benefit from expansionary fiscal stimulus. This sector view is supportive of positions in Goodman Group ((GMG)), REA Group ((REA)), Stockland ((SGP)), Super Retail and Wesfarmers.

Other more mid-cycle investments favoured by Morgan Stanley are the major banks and the resources sector in general with a preference towards industrial and base metal exposures. The order of preference for banks is Westpac Bank ((WBC)), ANZ Bank ((ANZ)), National Australia Bank ((NAB)) and Commonwealth Bank ((CBA)). 

Rcommended resources exposure includes BHP, Oil search ((OSH)), OZ Minerals ((OZL)), RIO Tinto and Sandfire Resources ((SFR)).

Rate Sensitive Stocks

Macquarie also expects higher bond yields, with the rise driven more by real yields, and has performed a review of their effect upon ASX valuations, leaving out the resources sectors.

From a starting point for which the ASX200 price earnings (PE) ratio is already high, the broker calculates a very strong negative correlation with a rise in yield. That is a rise in yields will negatively impact shares. This correlation becomes even stronger if only industrial shares are considered.

On a sector basis, the negative effects of a rise in real yields are the greatest for staples, healthcare, discretionary retail, technology, and media. However, based on current PE levels, the potential contraction in PE’s looks greatest for technology and media, explains Macquarie.

ASX100 stocks with the most negative correlations to real bond yields are forecast to be Goodman Group, ASX ((ASX)), ResMed ((RMD)), Woolworths ((WOW)), Wesfarmers, CSL ((CSL)), Altium ((ALU)), REA Group, IDP Education ((IEL)), Qube Holdings ((QUB)), Charter Hall Group ((CHC)), Coles ((COL)), Cochlear ((COH)), Fisher &  Paykel Healthcare ((FPH)) and Seek ((SEK)).

With the expectation of rising bond yields, Macquarie has also increased exposure to financials including Westpac, ANZ, Janus Henderson ((JHG)) and Computershare ((CPU)). In the investment bank’s view, the current retracement in reopening trades (eg lower oil and lower yields) is a response to a third wave in Europe and negative vaccine news. Nonetheless, this is seen as a buying opportunity in reflation trades and a bias towards value should be maintained.

Bond yields aside, Macquarie also recently updated its strategy portfolio to boost exposure to insurance via Suncorp Group ((SUN)), QBE Insurance Group ((QBE)) and Insurance Australia Group ((IAG)).

Energy sector exposures were also increased via Woodside Petroleum ((WPL)), Ampol ((ALD)), Worley ((WOR)), Origin Energy ((ORG)), BHP and Seven Group Holdings ((SVW)).

Finally, stocks that benefit from the travel boom were added including Qantas, Sydney Airport, Flight Centre and Crown Resorts ((CWN)) for when borders reopen.

Europe

A multi-year recovery in the global trade cycle should boost the more open markets in Europe. Oxford Economics expects a robust recovery in world trade next year, which will be positive for old-economy cyclicals. The expectation of continued US dollar weakness supports this view, as it is typically reflationary for global trade.

However, ANZ Bank has revised down its euro area GDP forecast for 2021 to 4% from 5%, to reflect the slow start to the European Union’s (EU) vaccination program. Quarter two is expected to be a period of transition toward a second half recovery as social conditions normalise and the stimulatory effects of the EU’s Recovery Fund will emerge.

The bank’s analysis shows that the presence of a very large output gap and a relatively slow recovery to pre-pandemic levels of GDP will combine with structural traits to deliver a subdued inflation outlook in the medium term.

Asian Economies

It is advanced economies that would seem to be at greater risk of any eventual taper tantrum than Asian economies, according to ANZ Bank. Somewhat unusually, Asia is likely to lead monetary tightening this cycle. China began restricting liquidity in 2020. Being at the forefront of hiking rates is quite different from the post-GFC experience for Asia.

The bank expects interest rate hikes in 2022 for South Korea, Indonesia, Malaysia, the Philippine, and Thailand. Along with improved current account dynamics, this is likely to give the region substantial resilience against the Fed’s eventual shift towards tightening, even if it is some time away.

Japan appears to hold widespread appeal for portfolio managers at present. T. Rowe Price maintains its exposure given the country is highly levered to global trade, which is expected to improve as global economies re-emerge over the coming months. Leading economic indicators are finally breaking through the expansion levels.

Domestic Japanese stocks are a global reflation play, with positive correlations to PMIs and bond yields, while solid earnings reports are confirming the global recovery. The Bank of Japan is expected to maintain its accommodative stance despite minor changes forecast in March.

In recent quarters exports and production have been substantive drivers of growth. Exports of automobile-related goods and IT have been notably strong. Exports of capital goods are increasing in synchronicity with stronger global industrial activity, particularly out of China, notes ANZ.

Morgan Stanley is similarly upbeat and recently added a hedged Japanese equities allocation to model portfolios, while strategists at Oxford Economics agree and believe that for those investors willing to take on risk in developed markets, both the UK and Japan appear to be the place to allocate additional funds, due to attractive entry levels.

Emerging Markets

T. Rowe Price likes emerging markets for exposure to cyclical areas of the economy that should benefit from broad global recovery. Current tailwinds include the Chinese economy remaining strong, US dollar weakness and attractive equity valuations relative to developed markets.

Negative factors include the potential for fading stimulus in China going forward, limited ability to enact fiscal stimulus (excluding China) and vaccine supply and distribution infrastructure that are well behind developed markets.

Citi feels that the current enthusiasm for emerging markets could face some challenges if the US dollar appreciates as they forecast. There are also concerns over China, including the recent National People’s Congress guidance to relatively low GDP growth of above 6% in 2021. With financial stability a key concern, contracting growth in money supply is likely to keep growth stable, but less supportive of outperformance from here.

In addition, fiscal consolidation will be larger than expected, as China’s micro, small and medium enterprises (MSME) will face a double-whammy impact on their cost side. Firstly, a resumption of social security contribution and secondly rising borrowing costs, which in turn may slow job creation and wage growth this year. This is not good news for a consumption rebound.

Finally, as China is the largest weighting in emerging markets and peak Chinese stimulus is behind us, the investment bank has reduced the EM Asia equity allocation to neutral.

While Citi sees Central and Eastern Europe, Middle East and Africa (CEEMEA) and the Latin American region (LatAm) suffering from a rising US dollar, equities have failed to retrace back to pre-covid-19 levels as yet.

This combined with their relative weakness on containment means that there is a greater opportunity for them to benefit from global reopening and vaccine deployment. LatAm and CEEMEA have been strongly lagging on the vaccine front, but will likely catch up in the second quarter.

ANZ, on the other hand, has a more robust view on China and believes the economy has already returned to its potential level of GDP, with the forecast for 2021 at 8.8%.

China’s industrial activity is undeniably strong with exports in the first two months of 2021 rising 60% year-on-year compared with a -17.2% fall in 2020. Consumer appetite is solid and online spending, express deliveries, box office revenues and local tours received a strong boost during the Lunar New Year holiday.

Commodity super cycle?

Commodity markets have climbed to their highest level since 2018 on hopes for a rebound in demand as the global economy reopens and travel resumes later this year.

A super-cycle is defined as an extended period of strong demand for a wide array of commodities, leading to a surge in prices. This will then end with a collapse in demand and a decline in prices. Such cycles tend to roughly coincide with periods of rapid industrialisation in the global economy.

As noted in the opening paragraphs, the world recovery has been uneven across different regions. However, with governments doubling down on support for their economies with ongoing fiscal and monetary measures, the spectre of synchronised global growth is not far away, according to ANZ.

This has emboldened investors to become increasingly bullish on the commodity sector outlook. Fund flows into commodity EFTs have been strong and money managers’ net positioning in the futures market in copper, oil, and corn have surpassed levels seen during the last bull run in 2010-11.

However, the ANZ is exercising restraint in forecasting a super cycle despite many factors in favour including the strong outlook for commodities amid ongoing stimulus measures and supply constraints. Also, the current rally has all the hallmarks of a commodity super-cycle, including unexpectedly strong demand and an ongoing supportive macroeconomic backdrop including a weaker US dollar.

Many of these short to medium term drivers remain tenuous, according to ANZ. China has already indicated it will ease stimulus measures later this year and the government is also cautious on the property sector, with new lending requirements likely to moderate growth in investment.

Infrastructure investment in China may also lag and as a consequence ANZ sees growth in steel demand moderating in the coming years. This is likely to weigh on the prices of steel making raw materials, such as iron ore and coking coal. 

Climate change policies are also expected to weigh on demand in certain sectors. Growth acceleration in the electric vehicle (EV) industry has the potential to weigh on gasoline and diesel fuel in coming years. With gasoline and distillate making up around half of all crude oil consumption, these developments could have a sizeable impact on demand. Finally, supply-side issues in the oil market are also expected to ease.

On the other hand, T. Rowe Price feels a new commodity super-cycle could be emerging with cyclical and secular trends finally in commodities favour, particularly among industrial metals. The worldwide push for cleaner, greener energy may keep upward pressure on commodities such as copper, platinum, and lithium for years to come, as many have limited supply.

Citi agrees with T. Rowe Price and is calling for a base metals super-cycle and a bullish stance on oil, though this is on a more cyclical basis. After collapsing in 2020 amid the pandemic-driven shock, oil prices have reached recent highs as demand has gradually recovered and supply has not kept pace. This is partially due to supply cut agreements from OPEC.

Apart from the favourable demand-supply backdrop, Citi points out good hedges for an inflationary environment are few and far between. Commodities could therefore benefit form a virtuous cycle, whereby inflation fears lead to investment inflows into commodity markets, which can then raise inflation fears even further. 

Gold prices have climbed over 40% since 2018, and Wells Fargo believes that more gains lie ahead. Prices have pushed higher on the back of trends including low global real interest rates, excessive money printing and a weak US dollar. These trends remain largely intact and Wells Fargo remains a gold bull with a 2021 target range of US$2,100-2,200/oz. Another important tailwind for gold in 2021 and beyond is dwindling supply growth.

Gold and other precious metals may act as a volatility hedge to portfolios diversifying away from low fixed-income yields, and agricultural commodity prices may continue to climb on rising demand.

Bonds and credit

Wells Fargo believes the near 40-year bull market in bond prices is winding down. Interest rates are expected to rise modestly and then remain near historical lows, likely negating the opportunity for significant capital gains in fixed income.

In today’s low-yield environment, income investors should consider allocations to high-yielding fixed-income classes, including corporate bonds and emerging market bonds.

On that point, Citi has upgraded US high yield to Neutral from Underweight as history suggests high yield spreads follow a similar path to equities in the current economic environment. Equity valuations enjoy a ‘Goldilocks’ environment when inflation is a ‘little positive’, as at the moment. When there is deflation the situation is not-so-great and when inflation is greater than 4% a painful de-rating process ensues.

Oxford Economics’ view on weak inflatio, leads to a paring back of an Underweight position in government bonds. While the view remains for higher US bond yields over the medium term, technically the sell-off in the ten-year bonds looks stretched.

Currencies

Citi’s foreign exchange team thinks the US dollar may be bottoming with some plausible strengthening as the economy reopens and bond yields increase.

Against a challenging backdrop of lockdowns and vaccine shortages the European Central Bank (ECB) is stepping up bond purchases in the second quarter to prevent rising sovereign bond yields from getting too far ahead of the business cycle. ANZ Bank believes this will reinforce the negative term structure of interest rates and provide a headwind for the euro, which the ECB will embrace given the persistent undershoot in inflation.

For the Australian dollar, ANZ maintains a year-end target of US82c and expects the currency to outperform most G10 peers as the global recovery matures. As the flag-bearer for global reflation, the combination of risk appetite and confidence in global growth is expected to be supportive.

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For more info SHARE ANALYSIS: REA - REA GROUP LIMITED

For more info SHARE ANALYSIS: RIO - RIO TINTO LIMITED

For more info SHARE ANALYSIS: RMD - RESMED INC

For more info SHARE ANALYSIS: RWC - RELIANCE WORLDWIDE CORPORATION LIMITED

For more info SHARE ANALYSIS: SEK - SEEK LIMITED

For more info SHARE ANALYSIS: SFR - SANDFIRE RESOURCES NL

For more info SHARE ANALYSIS: SGP - STOCKLAND

For more info SHARE ANALYSIS: SKC - SKY CITY ENTERTAINMENT GROUP LIMITED

For more info SHARE ANALYSIS: SUL - SUPER RETAIL GROUP LIMITED

For more info SHARE ANALYSIS: SUN - SUNCORP GROUP LIMITED

For more info SHARE ANALYSIS: SVW - SEVEN GROUP HOLDINGS LIMITED

For more info SHARE ANALYSIS: SYD - SYDNEY AIRPORT HOLDINGS LIMITED

For more info SHARE ANALYSIS: WBC - WESTPAC BANKING CORPORATION

For more info SHARE ANALYSIS: WEB - WEBJET LIMITED

For more info SHARE ANALYSIS: WES - WESFARMERS LIMITED

For more info SHARE ANALYSIS: WOR - WORLEY LIMITED

For more info SHARE ANALYSIS: WOW - WOOLWORTHS LIMITED

For more info SHARE ANALYSIS: WPL - WOODSIDE PETROLEUM LIMITED