Economic data continued to strengthen during May and markets generally made further progress after a strong start to the year. The ongoing vaccine rollout is continuing to allow many economies to gradually reopen which combined with continued fiscal and monetary support, particularly in the UK and US, is supporting a rapid recovery in economic activity.
The concern that more persistent inflation could result from this expansion, forcing central banks to bring it to a premature end, has constrained further rises in equity markets, and companies in sectors where the pandemic has had a greater impact continue to outperform more expensive growth stocks in sectors such as technology.
Vaccination programmes continue to be vital and data on their efficacy has been largely positive, reflected in low hospitalisation rates in those countries such as the UK and US where sizeable proportions of the population have been inoculated. Developing economies remain vulnerable and the crisis in India has highlighted the need for a rapid rollout globally including developing nations. Although Far East countries have contained the virus very effectively and seen much lower numbers of deaths, vaccine programmes there are lagging with the Japanese economy contracting significantly during the first quarter.
The US economy is continuing to see rapid recovery with consumer demand buoyant and data from manufacturing and services highly positive. The accompanied increase in input costs and signs of upward pressure on wages are giving markets some concerns however. A headline inflation rate of 4.25% year on year for April was higher than anticipated and whether or not elevated inflation is transitory is one of the biggest questions for investors, particularly in the US. So far, the US Federal Reserve has not indicated that there will be any rapid change of policy and they continue to believe that there are temporary factors impacting inflation.
The reopening of the UK economy continued in May with indoor hospitality reopening and an easing of restrictions on social mixing. Impressive retail sales growth has highlighted strong demand, again creating price pressures for businesses as input costs rise.
After a slow start, vaccination rates in Europe have picked up and this has encouraged prospects for robust economic recovery in the second half, helping equity markets outperform other developed markets during May.
Asian equities have been subdued since February after a strong end to 2020 and start to this year. This reflects the more limited impact of the pandemic and recovery being at a more advanced stage than the US and Europe but also concerns over lower vaccination rates and unexpected COVID-19 outbreaks in certain countries, Taiwan being a recent example. The Chinese stock market has seen a significant correction this year centred on high growth companies as monetary policy has been tightened. This may provide a more attractive long term entry point.
The economic outlook for the second half of 2021 appears positive particularly where strong progress with vaccinations has been made. As more countries move to the position where vaccinations mean that restrictions can be removed, economic recovery should broaden out. The question will then be how strong growth should be and whether central banks will react to more rapid expansion by removing support and raising interest rates quickly to prevent persistent inflation. This is likely to create some market volatility over the coming months, but provided inflation remains modest, stock markets should have the potential to add further gains with businesses able to pass higher input prices onto customers where demand is strong.
|2021 Year to Date|
|FTSE World ex-UK (GBP)||+8.39%|
|FTSE Actuaries UK Conventional Gilt All Stocks||-6.58%|
|FTSE Actuaries UK Index-Linked All Stocks||-2.65%|
Performance to 04/06/2021
|Bank of England Base Rate||0.10%|
|Inflation (Retail Prices Index)*||2.90%|
* April 2021