Equity prices climbing higher, while mixed messages on inflation appear

• June turned out to be one of the best periods this year, as both equity and bond prices showed steady price increase;
• Despite another high reading on inflation, majority of assets traded as if disinflation is about to start.

Summer started on a positive note for majority of the financial assets, with almost uninterrupted gradual rise in prices of major equity indices and large number of them making new all‑time highs. Moreover, June was especially favorable month to instruments denominated in EUR, as decline in European currency vs US dollar by 3% during this time led to additional gains - global equity index (MSCI ACWI) increased by 4.6% in EUR terms. In addition, contrary, to what was usually observed throughout 2021, June was also quite favorable month to bond prices, as all largest bond sub‑asset classes also increased in price throughout the month. The only universe with negative market dynamics was related to commodities, as some of them, such as gold, copper, and especially lumber experienced rather sharp selloffs.

Performance of selected assets in June in EUR terms

Source: Bloomberg Finance L.P.

In terms of market events, June was somewhat uneventful. US politicians continued to negotiate details behind new multi‑year infrastructure plan with democrats and republicans getting closer to finding compromise on how the final bill should look like. At the same time not announcing any additional fiscal measures. 

ECB and FED held their meetings in June, but there were also neither big surprises, nor any change in rhetoric that their easing policies and bond purchase programs would end anytime soon. FED sticked to its view that inflationary pressures are transitory, while most of FOMC¹ continued not to expect any interest rate hikes at least until 2023. 

Interesting, that in June market participants somewhat agreed with FED on the view that inflation might not be a major risk factor after all. Despite another high inflation print released in June, with annual core inflation in USA reaching highest value in almost 30 years, assets that are benefiting from rising inflation have struggled, while those that benefit from disinflation or even deflation have gained. 

US core CPI (y-o-y change)

Source: Bloomberg Finance L.P.

Opposite to May, materials and financials sectors were among the weakest ones in terms of performance, while IT and consumer discretionary sectors increased the most. “Value” stocks have also struggled and actually declined in price, while “growth” equities were the ones that drove equity indices higher. In fact, on the closer look, June once again demonstrated uneven market dynamics  observed so far in 2021, which we have already mentioned in previous reports - while equity indices are rising, beneath the surface large number of ideas actually either remain flat or fall in price.

It might seem quite surprising, but while in mid‑April more than 90% of equities in S&P‑500 remained in uptrend as measured by price staying above its 50‑day moving average, by the end of June less than 50% of components still continued to be in rising trend as described by this metric. Meanwhile S&P‑500 during this period went to new all‑time highs. How did it become possible? Key explanation is very strong performance from largest technology companies. Rise in prices of Apple, Microsoft, Amazon, Google, Facebook, Tesla and Nvidia was more than enough to compensate for negative performance of large number of smaller stocks included in the index. Still, such dynamics should not be taken lightly – when market breadth deteriorates and only few largest names continue to show solid returns, it often precedes market corrections of various degrees.

S&P-500 and % of members above 50-day moving average

Source: Bloomberg Finance L.P.
Performance of selected equities vs S&P‑500

Source: Bloomberg Finance L.P.

But let us return to the topic of inflation and asset class performance. In June, global bond yields continued to decline and there was also sharp reversal in multiple commodity prices. These are not developments that should be expected when inflation rate is expected to accelerate. In fact, these events potentially hint that inflation might have peaked and soon would start to deaccelerate. 

It might certainly happen.  With further lifting of COVID‑19 restrictions and more progress with economic reopening, demand/supply disbalances might get restored, stabilizing prices. In addition, governments are unlikely to introduce any new stimulus measures that can boost demand even further right now, while central banks are also unlikely to bring any new monetary stimulus. As a result, with no more stimuli, prices again might stabilize without rising any further. 

However, it is still to early to jump to deliberate conclusions. What we saw in June might turn out to be simply profit taking, with investors deciding to realize some gains before summer season starts. All reasons on why inflation may remain persistent²  continue to be in place and going forward inflationary assets once again may show strong outperformance.

As an example, let us look at lumber, material that is widely used in housing construction and is very sensible to inflation expectations. Excess savings and stimulus measures boosted demand for new houses and created deficit for lumber this and last year. As a result, lumber futures price increased by ~550% since bottom at 260 USD in early April 2020 for contract till top at 1686 USD in early May 2021. Since that time in less than two months price has corrected by almost 60%. Should we say that it is a clear signal that inflation threat is over? Unfortunately, no. In September – October 2020, material has already corrected by ~45% only to increase by more than 200% in later months as inflationary pressures continued to build up. It cannot be excluded that something similar would happen later this year as well. 

Price of lumber

Source: Bloomberg Finance L.P.

July may turn out to be another calm and positive month. No significant events are planned until the end of the month when central bank meetings would take place. Some concern may be caused by spread of new COVID‑19 variant, which tends to spread more rapidly and has already led to jump in new cases in UK and some other countries despite high vaccination numbers there. But as share of vaccinated global population continues to increase and new cases in majority of countries are still trending lower, it should not act as a major threat for financial markets. Also, in July, companies will start releasing their financial results for the second quarter 2021. Analyst expectations remain high, but given the amount of fiscal stimulus that was released early on this year, it is reasonable to expect that corporations once again would be able to beat estimates with strong numbers. 

¹Federal Open Market Committee – FED’s monetary policy decision making body, consisting of 12 voting members.
²For more detailed discussion of these reasons please refer to our June 2021 market update.