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Market Analysis 14/05/2021


Inflation worries drag stocks down from record highs Stocks slipped back from record highs as investors confronted stark signs of higher inflation, but a late rally moderated the week’s declines. Weakness in Tesla weighed especially on consumer discretionary shares, and Elon Musk’s announcement that electric vehicle maker would no longer accept Bitcoin as payment because of its carbon footprint sparked a sell-off in the cryptocurrency. At its low point on Wednesday, the technology-heavy Nasdaq Composite index was down roughly 8.5% from its intraday April 29 peak, still above the widely accepted 10% threshold for a correction. T. Rowe Price traders observed that market volumes also remained relatively muted given the volatility. Core inflation sees biggest monthly jump since 1982 The week brought more data surprises on the heels of the previous Friday’s substantially weaker-than-expected jobs report for April. On Wednesday, the S&P 500 Index had its worst day since February 25—and the Dow Jones Industrial Average had its worst since October 28—after the Labor Department reported that core (excluding food and energy) consumer prices jumped by 0.9% in April, the most in nearly four decades and roughly triple consensus estimates. The headline consumer price index (CPI) rose 4.2% over the 12 months ended in April, exceeding forecasts for a 3.6% increase. Producer prices, reported Thursday, rose 0.6%, roughly double expectations. Stocks recovered some momentum on Thursday, however, seemingly helped by a bigger-than-anticipated drop in weekly jobless claims to another pandemic-era low of 473,000. April retail sales, reported Friday, were flat for the month, but that followed a March sales surge that was revised higher, to 10.7%. The economy’s continued reopening was reflected in healthy gains in spending at bars and restaurants, and the Centers for Disease Control and Prevention surprised many by revising its guidance to say that fully vaccinated people do not need to wear face masks or socially distance in most circumstances indoors. Fed officials stress inflation is likely to prove temporary The market’s partial recovery late in the week may have also reflected a growing consensus that the choppy economic signals were due to temporary dislocations from the pandemic, particularly on the inflation front. Rental car prices jumped 10% in April, a function partly of agencies selling off their fleets to stay afloat in 2020. Airline fares also jumped 10% and hotel prices rose nearly 9%, as many Americans resumed travel. Worries over the hacker-induced shutdown of a major gasoline pipeline operated by Colonial Pipeline, the primary supplier to much of the Southeast, also faded after operations were partially restored on Wednesday evening. Federal Reserve officials also made repeated assurances that the inflation data would not prompt any sudden shift in monetary policy. On Wednesday, Fed Vice Chair Richard Clarida acknowledged being surprised by the morning’s data, but he stated that a temporary surge in inflation remained “entirely consistent” with the Fed’s goals. Lael Brainard and Mary Daly, two other central bank officials, also stressed that the economy remained far from the Fed’s employment goals. Bond yields increase but stay below recent peaks The bond market seemed to take its cue from the Fed, with the yield on the benchmark 10-year U.S. Treasury note increasing but staying well below its late-March highs. (Bond prices and yields move in opposite directions.) Municipal bonds outperformed Treasuries through most of the week but posted negative returns. According to the firm’s municipal traders, primary market demand was soft at midweek amid the sell-off in Treasuries but improved on Thursday. Technical conditions continued to be buoyed by positive inflows into municipal bond funds industrywide, with Lipper reporting inflows of USD 750 million for the week ended Wednesday. Robust overnight demand from Asia was supportive of investment-grade corporate bonds. However, inflation headlines and weakness in the Nasdaq early in the week weighed on the market. The primary calendar was most active on Monday, marking the heaviest day of new issuance in 2021. Meanwhile, high yield bond investors and broader risk markets were largely focused on renewed inflation fears. High yield funds industrywide reported outflows.


Shares in Europe fell with global markets amid signs of accelerating inflation, stoking fears that interest rates could increase. In local currency terms, the pan-European STOXX Europe 600 Index ended the week 0.54% lower. Major indexes were mixed. Germany’s Xetra DAX and France’s CAC 40 were little changed, but Italy’s FTSE MIB rose 0.63%. The UK’s FTSE 100 pulled back 1.21%, in part because the British pound appreciated relative to the U.S. dollar after local election victories for the ruling Conservative Party. The FTSE 100 Index tends to fall when the pound rises because many companies in the index are multinationals that generate a meaningful proportion of their revenue abroad. Core eurozone bond yields rose. A higher-than-expected inflation print in the U.S. triggered a sell-off in high-quality government bonds, causing core yields to rise in tandem with U.S. Treasury yields. Peripheral eurozone bonds largely tracked the moves in core markets. Fears of the European Central Bank (ECB) slowing bond purchases also pushed yields higher. UK gilt yields also tracked U.S. Treasury yields amid global weakness in government bonds. Indian variant of coronavirus sparks concern The European Commission (EC) called on European Union (EU) countries to halt nonessential travel from India to limit the spread of a coronavirus variant that the World Health Organization classified as being “of concern.” The UK government said further relaxation of the lockdown would go ahead on May 17, even though there are worries about the Indian variant. News reports said that officials are contemplating stepped-up testing for the coronavirus and bringing forward a second dose of the vaccine in virus hotspots. The EU’s medicines agency said it is “pretty confident” that the current vaccines approved for use are effective against the variant. ECB minutes: financing conditions stable; EC raises growth forecasts The minutes of the ECB’s most recent policy meeting suggested that the governing council was satisfied with market developments going into the April meeting. There was broad agreement that euro area financing conditions had remained broadly stable since the March meeting. The statement also noted that measures of underlying inflation continued to hover around levels seen in spring 2020. The EC revised its economic growth forecasts to 4.3% for 2021 and to 4.4% for 2022—an increase from previous estimates of 3.8% in both years. Rising vaccination rates, the prospect of lockdowns easing across the region, and improving export demand prompted these upward revisions. UK gross domestic product in March grew a stronger-than-expected 2.1% sequentially, led by the reopening of schools, vaccine rollouts, and pickups in the retail and construction sectors. The expansion helped reduce the rate at which the economy contracted in the first quarter to 1.5%. Bank of England (BoE) Governor Andrew Bailey said the central bank is watching the inflation situation carefully but does not think that the factors driving up consumer prices will last.


Japan’s stock markets registered sizable losses for the week amid a bout of volatility following an unexpectedly sharp rise in the U.S. consumer price index. Accelerating coronavirus infection rates and the announcement that a state of emergency will be declared in three more prefectures also dampened risk sentiment. The Nikkei 225 fell 4.34% while the broader TOPIX Index was down 2.57%. Risk-off sentiment led the 10-year Japanese government bond yield to rise to 0.09%, while the yen weakened slightly, finishing the week at around JPY 109.41 against the U.S. dollar. Consumer demand rebounds strongly Data showed that consumer demand rebounded strongly from the heavy blow it took from the worsening impact of the coronavirus pandemic last year. Household spending rose 6.2% year on year in March, stronger than consensus expectations and following a 6.6% drop in the previous month. Items aligning with the stay-at-home theme, such as PCs, TVs, and internet plans, were in high demand. Conversely, coronavirus-affected categories, including dining, tourism, and transportation fares, were out of favor. Many believe, however, that spending is likely to remain under pressure given the extension of new state of emergency restrictions and slow vaccine rollouts. State of emergency extended further Three more prefectures are to come under a state of emergency in a surprise move by the government. It follows calls from local governors for the government to consider expanding a state of emergency nationwide. Prime Minister Yoshihide Suga’s popularity has been hit by what many perceive as the government’s inadequate coronavirus response. SoftBank Group posts record profit for a Japanese company On the corporate front, telecommunications and internet conglomerate SoftBank Group posted the highest-ever annual net profit for a Japanese company. Its Vision Fund has been boosted by a vibrant U.S. market for initial public offerings (IPOs), particularly the listing of South Korean e-commerce giant Coupang. Shares tumbled following the announcement, however, after the conglomerate did not extend its buyback program, removing support for the stock as concern over frothy valuations appeared to outweigh the record earnings. CEO Masayoshi Son said that he wants to more than double its Vision Fund portfolio to 500 companies, building a pipeline that generates listings of dozens of companies every year. The pledge to redouble the strategy behind the Vision Fund comes as tech valuations are under pressure: Coupang has fallen sharply since its March IPO, while other major portfolio companies, including Alibaba Group and Uber Technologies, have also declined.


Chinese stocks rose strongly for the week. The benchmark Shanghai Stock Exchange Composite Index gained 2.1%, while the large-cap CSI 300 Index advanced 2.3%. The yield on China’s sovereign 10-year bond ended unchanged at 3.17% after a week of mixed economic data. China reported net inflows of USD 9 billion into the country’s government bonds in April. Beijing is keen to attract foreign investment into its domestic “green bond” market, used to finance renewable energy and other green projects. In currency trading, the renminbi gained 0.3% against the U.S. dollar, closing at 6.434 per dollar. On the economic front, auto sales increased for the 13th straight month in April, rising 8.6% over a year ago. China’s producer price index jumped 6.8% in April, the largest gain since 2017, as raw materials prices surged. However, the CPI rose a less-than-expected 0.9%, restrained by lower food prices. Despite the muted CPI reading, analysts see core consumer inflation on the rise as prices in the services sector start to normalize after the coronavirus pandemic. Aggregate finance—a broad measure of credit in the economy—rose 11.7% in April, down markedly from the previous month and the slowest growth pace since March 2020, when China’s economy started to reopen, according to CLSA. In corporate news, e-commerce leader Alibaba reported better-than-expected revenue in the first quarter, but its earnings lagged forecasts owing to higher costs for new strategic initiatives. Beijing revisits property tax China’s top leaders are considering a residential property tax, a reform that Beijing has debated in recent years, reported the South China Morning Post. News of the proposal follows recent statements by Premier Li Keqiang regarding rising home unaffordability as a concern for the government. The Ministry of Finance is consulting with other ministries, local governments, and industry experts on a pilot scheme for taxing real estate, one means of keeping a lid on surging home prices. Analysts expect China’s property sector will remain strong this year, given stable mortgage rates, low supply, and strong land sales in 2020. New housing starts and completions in March declined 3.7% and 2.2%, respectively, from the same period in 2019. Home prices are a concern for Beijing because they are seen as a factor behind China’s declining birth rate, which has implications for the labor supply and pension system. China’s delayed 2020 census data showed a shrinking working-age population and continued drop in birth numbers. The country’s population recorded an average annual growth rate of just 0.53% in the past decade, a six-decade low, while new births dropped 18% in 2020 for the fourth straight year. The census also revealed that China’s total fertility rate—or the average number of children born to a woman over her lifetime—was well below the number for Asia and the rest of the world. Analysts believe that the government will respond by postponing the retirement age, relaxing urban residency rules, and offering child-care services to encourage families to have more children.


MEXICO Mexican stocks, as measured by the IPC Index, were little changed. On Thursday, the Mexican central bank held its regularly scheduled monetary policy meeting, and policymakers decided unanimously to keep the overnight interbank interest rate at 4.00%, where it has been since a quarter-point rate cut on February 11. In their post-meeting statement, Governing Board members concluded that the balance of risks for inflation is biased to the upside and cited a recent year-over-year inflation reading of 6.08% through April as being higher than anticipated. T. Rowe Price emerging markets sovereign analyst Aaron Gifford observes that Mexican inflation is at a 3.5-year high, largely because of non-core price components, especially energy costs. However, he does see some pressures in the cost of core goods, including processed foods, and, to a lesser extent, services costs. While most of these price pressures could be considered transitory, Gifford believes that last year’s disinflation is clearly dissipating as the economy is reopening. Central bank officials seem to believe that supply shocks from the pandemic will ease over time, but Gifford is cautious about the potential for rising commodity prices to have a second-round effect on consumer prices. Nevertheless, he believes that inflation could peak in the next couple of months, though it is uncertain how quickly it may decline thereafter. BRAZIL Shares in Brazil, as measured by the Bovespa Index, returned about -0.2%. On Tuesday, the Brazilian government reported that inflation rose 0.31% month over month in April, which was slightly stronger than expected. It seemed to be a rare month without a major price shock, as food and fuel prices were stable, and services inflation remained low. Also, manufactured goods price pressures have slowly eased in recent months. However, there could be an uptick in inflation next month stemming from higher electricity costs, as Brazil’s electricity regulator recently raised reservoir level-related surcharges on electricity prices due to low water levels. Also on Tuesday, the central bank released the minutes of its May 4–5 monetary policy meeting, at which policymakers decided, as expected, to raise the benchmark Selic interest rate from 2.75% to 3.50%. Central bank officials appear to be dovish by pursuing a “partial normalization” of the Selic rate, with the intention to keep it below a neutral level and thus continue to provide some monetary stimulus as the Brazilian economy recovers. However, due to inflation pressures, some investors may be skeptical that the central bank will be able to pause its rate increases.

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