There was both good news and bad news from Bank of Singapore (BOS) head of investment strategy Eli Lee as he predicted US peak quarterly growth to arrive some time in 2021. The downside is that given “what goes up must come down”. Growth is likely to wane in the latter part of the year and into 2022.
Incoming economic data corroborates with Lee’s 6.8% growth projection for the US economy. Manufacturing in the US also seems to be recovering, with the US recording an ISM manufacturing Purchasing Managers Index (PMI) of 64.7 - a multi-decade record. This has since eased to 60.7 in April.
Unfortunately, reality is seen to quickly set in, as net fiscal impulse - or the measure of how government spending influences the economy in the short-run - is seen to fall in 2022-2023 on a relative basis. Despite around US$4.1 trillion ($5.4 trillion) in fiscal stimulus offered by the Biden administration, corresponding tax hikes and 8-10 year timeline is likely to blunt its impact.
While the size of this fiscal stimulus is indeed considerable, Lee does not anticipate unbridled inflation to take hold. “While inflation fears are likely to overshoot over the near term due to base effects and as growth reaches a crescendo, we believe that an easing in economic growth after will conversely help alleviate fears of an inflation crisis,” he remarks.
Much of the inflation is caused by temporary forces like long delivery times and low inventories. These are likely to be resolved as the recovery takes hold. Disappointing non-farm payroll figures of US$226,000 relative to the expected US$1 million also suggests that some time must pass before labour market slack can be absorbed and inflationary pressures rise significantly.
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Some see the present commodity bull driving inflation, the correlation between commodity prices and inflation is tenuous. But Lee says that core inflation levels did not rise above the trend in a “sustainable way” during the last commodity bull run in the early 2000s.
“Looking ahead, even as we maintain a positive outlook for markets against a healthy backdrop for earnings and economic growth with abundant liquidity, our conviction is rightly lower as the risk-reward has become less attractive given higher risk asset prices,” says Lee.
The present rise in bond yields are seen to hit their limit as growth in the US moves past its peak, A sharp rise in bond yields, says Lee, has led to recent turbulence in long duration assets like investment grade bonds and tech growth stocks. This is seen to ease as scope for a significant near-term spike in bond yields becomes more limited.
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Earnings growth will become increasingly important in driving equity upside as financial markets. Lee favours “marquee blue-chip tech stocks with solid earning prospects”. Yet he warns that there are greater risks associated with such plays as economic re-opening intensifies, as some of these stocks do not have stable earnings profiles and have benefited from the pandemic’s “work-from-home” narrative.
“Given that valuations indicators, such as the high price-to-earnings ratios and equity-to-bond ratio are near cycle highs, there is a case to be made that buoyant equity markets have already made significant progress in discounting the economic recovery,” notes Lee. Most of the easy gains from the rotation from frowths to cyclicals are now past, with investors having to be more selective in terms of bottom-up individual stock selection.
