In this week’s market update: earnings continue to outperform expectations; commodities rise as economies re-open; and the dollar slides as the rest of the world catches up
Markets were closed here in the UK for the bank holiday but remained open in the rest of Europe and in the US. On both sides of the Atlantic, shares added to recent gains as investors focused on strong manufacturing data and continuing good earnings reports.
Cyclical sectors such as energy, materials and industrials were the main beneficiaries as factory output remained at high levels despite marginally missing the most optimistic expectations. The US ISM survey showed manufacturing activity down from March’s 37 year high in April but at 60.7 the measure was well above the 50 level that separates expansion from contraction.
In Europe, the purchasing managers index for manufacturing edged higher to 62.9 in April, a second consecutive monthly record as the region’s powerful export sector benefited from the upswing in the global economy as many (not all, it goes without saying) start to emerge from the Covid pandemic.
Growth in many economies is feeding through into improving corporate earnings. According to FactSet, of the 306 S&P 500 companies that had reported figures for the first quarter of 2021, 268 had beaten expectations.
And it’s not just a US success story. In continental Europe earnings growth has reached 75%, albeit from last year’s low base. Expectations have been beaten by a record 15 percentage points, marking the biggest positive surprise for investors since the world came out of the financial crisis in 2009.
There are still plenty of earnings reports to come this week, although fewer big themes than in recent weeks when first the banks and then Big Tech all reported results within days of each other.
This week we will lift the lid on vaccine makers Pfizer and Moderna. The automotive industry is in focus with General Motors and Volkswagen. Ahead of the expected re-opening of international travel this month, British Airways owner IAG will announce its latest quarterly figures, three months after it unveiled its biggest ever loss in February.
Here in the UK, there’s a range of results from housebuilder Barratt to retailer Next and the commodities giant Rio Tinto.
Rio’s figures will be particularly interesting against a backdrop of speculation that we are in the early stages of a commodities supercycle, an extended period of rising prices for natural resources.
The commodities sector is extremely cyclical and upswings and retrenchments can last for many years when significant changes in the global supply and demand balance occur. Previous examples have included the industrialisation of America in the second half of the 19th century and early part of the 20th. Then the recovery from the Second World War in Europe and Japan. And more recently the integration of China into the global economy and the rapid promotion of millions of that country’s citizens from poverty into a new consuming middle class.
All of these big shifts tilted the supply/demand balance and led to extended periods of rising prices for the building blocks of the global economy - energy, industrial metals and agricultural commodities.
The big story on which advocates of a new supercycle are pinning their hopes is the decarbonisation of the global economy. Building a greener world, characterised by sustainable energy generation and
electric transport, is a key component of the massive fiscal stimulus being implemented in many countries but notably in the US. A third of Joe Biden’s so-called American Jobs Plan - a $2.3trn infrastructure programme - is earmarked for transport infrastructure and electric vehicles. China, too is pushing towards an electric only transport system while here in Europe many countries are mandating the end of the internal combustion engine within a matter of years.
This is going to lead to a huge upsurge in demand for the metals that underpin the green economy - copper, nickel, aluminium, platinum. Glencore, the metals trader and miner, estimates that demand for copper could double over 30 years.
This is already starting to be reflected in the price of the metal, which has doubled over the past year from $4,300 a tonne to $10,000 for the first time in a decade last week.
Of course, rising demand would not necessarily increase the price of metals were supply able to rise in tandem. However, capital investment is thought to be well below what is needed to match the growth in demand. It can take years to develop a new mine and in recent years companies have been more focused on returning cash to shareholders than on preparing for the next commodities boom.
Not all commodities have seen copper’s spectacular growth, but records are still falling across the resources spectrum. The price of timber hit a new record high this week, corn rose above $7 a bushel for the first time in eight years and the S&P GSCI index, which tracks 24 key raw materials, has risen by 24% just in the first four months of this year.
One of the key commodities, of course, is oil. While the price of crude has risen sharply since the low point during the early stages of the pandemic last spring, it remains constrained by a lack of international travel. Once that situation eases, with signs that holidays could be back on the agenda this summer, then oil could rise further from today’s $65. Goldman Sachs expects it to hit $80 a barrel in the second half of the year.
One asset that tends to move the other way as the economy picks up is the US dollar, traditionally seen as a safe haven in bad times and less in demand when things improve.
The dollar has weakened recently as investors have taken the view that the rest of the world will not be far behind the US’s recovery. Another factor is the attraction of currencies tied to rising commodity prices. Despite its difficult Covid situation, the Brazilian real has been the best performing currency over the past month.
Similarly, despite the backward-looking economic data in Europe looking poor - with the region entering a second recession in a year - expectations of a faster vaccination programme and a revival of tourism has seen the euro pick up the pace, rising 3% to $1.20.
The dollar has also slipped on the back of the Fed’s concerted efforts to stress its continuing easing bias. The US central bank has stressed that it is in no hurry to wind down its asset purchasing programme.
And finally, a quick look at the outlook for dividends, a key plank in the case for the UK stock market, a market that also has attractions in the form of a heavy exposure to that booming commodity sector and a tilt towards the cyclical value sectors which are outperforming today.
In the first quarter of this year, 12 of the FTSE 100 constituents returned to the dividend list and strong results in the latest batch of earnings announcements suggest there could be strong growth in dividends to come.
That’s just as well following last year’s 38% fall in dividend payments but with traditional dividend payers like BP and HSBC performing well, now might be an interesting time to look once again at equity income funds, long out of favour with investors.
With yields of between 3.5% and 5% for many UK equity income funds, the potential total returns from this sector may make this a good year for a part of the market that has been easy to overlook in recent years.
Other things to watch out for in this shortened week include: the latest from the Bank of England, which concludes its rate-setting meeting on Thursday; Friday’s non-farm payroll data in America; and Thursday’s elections here in the UK. Perhaps most important of these is the Scottish parliamentary election, which could have significant implications for the future of the UK. More on that next week.