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Inflation concerns likely a temporary issue

06/04/2021

Key Takeaways

  • Inflation concerns have driven bond yields higher. Short-term volatility may persist but we think this will be temporary and mild.
  • Over the next 3-6 months, we think equities will rally further thanks to the earnings recovery but longer-term investors may wish to start reducing exposure in more expensive asset classes.
  • Over a 12 month horizon, we are positive on Global Equities but have downgraded US, South Korea & Taiwan to Neutral. We have also downgraded US High Yield Bonds to Neutral. They have rallied and are now less attractive from a valuation perspective.

Talking Points

1. What is the impact of higher inflation expectations?

  • Bond yields have risen amid higher inflation expectations driven by an improving outlook, higher commodity prices, supply chain bottlenecks, and $1.9 trillion US fiscal stimulus. Inflation concerns have also put into focus whether central banks will tighten monetary policy, creating volatility in bonds and equities.
  • We believe inflation concerns to be temporary and mild. The US is operating at below full employment and wage growth is limited. Year-end, we expect US inflation at 2.1% and the 10-year US Treasury yield to be 1%. We are optimistic on growth and have upgraded global and US GDP forecast to 5.6% and 6%.
  • In fixed income. we like Asia and China high yield bonds, US Investment Grade for high quality, low duration exposure, in addition to Emerging Market debt (denominated in both local currency and USD) which stand to benefit from the continued recovery.  

Source: Bloomberg, data as of 30 March 2021. Forecasts are subject to change. Investment involves risks. Past performance is not an indication for future. For illustrative purpose only.

2. Can the equities rally continue?

  • Over 3-6 months, we remain overweight equities because we think the improving earnings outlook will drive stocks higher. Geographically, we like US, UK and Asia (China and Singapore). We prefer cyclical sectors exposed to the recovery like financials, industrials, materials and consumer discretionary.
  • While we think the stock market can rally further short-term, longer-term investors may wish to consider trimming exposure in areas which are now more pricey.
  • Over a 12 month horizon, we have downgraded Taiwan and South Korea equities, which are now more expensively valued. We have also downgraded US equities because of the higher valuations of the mega-cap tech sector, which makes up a significant part of the market. 

Source: Refinitiv DataStream, HSBC Global Research, data as of 30 March 2021. Investment involves risks. Past performance is not an indication for future. For illustrative purpose only.

3. What are some of the key risks facing investors?

  • Short-term market volatility may persist if inflation remains elevated, as markets process whether and when monetary policy may tighten. We think these concerns are temporary and equities will do well over the next 3-6 months. Central banks are committed to keeping policy loose to stimulate the recovery.
  • If real yields remain elevated, certain growth sectors like tech may suffer short-term, even though we see tech more as a structural investment. Gold may also suffer short-term if real yields continue to rise.
  • Delays or poor take-up of the Covid-19 vaccine and new variants or waves of virus are risks to the recovery. We advocate investing via a multi-asset approach that includes a range of asset classes, geographies and sectors, including high quality bonds.

Source: Bloomberg, data as of 30 March 2021. Investment involves risks. Past performance is not an indication for future. For illustrative purpose only.

House views

 

Our latest short-term (3-6 months) and long-term (>12 months) views on various asset classes

Global

Economic data points to a strong global recovery, bolstered by vaccine roll-out. Cyclical stocks stand to benefit.

overweight
Overweight
Short-term
overweight

Overweight

Long-term
United States

Earnings outlook is strong and we expect US equities to outperform over 3-6 months. However, longer term investors may wish to trim exposure in light of higher valuations driven by mega-cap tech stocks. We moved to Neutral on US equities on a long-term basis and would focus on real economy names and smaller caps.

overweight
Overweight
Short-term
Neutral
Neutral
Long-term
United Kingdom

UK equities valuation is attractive and stand to benefit from the expansionary budget, successful large-scale COVID-19 vaccine program and the subsequent re-opening of economies. 

overweight
Overweight
Short-term
overweight

Overweight

Long-term
Eurozone

A dovish ECB, committed quantitative easing and generous national income support schemes bode well for Eurozone equities, however we remain neutral due to slow pace of vaccine rollout and recovery in the EU.

 Neutral
Neutral
Short-term
overweight

Overweight

Long-term
Japan

Japanese equities are attractively valued, but economic growth is weak and policy space is limited.

 Neutral
Neutral
Short-term
 Neutral
Neutral
Long-term
Emerging Markets (EM)

The outlook for EM asset classes remains broadly positive driven by global recovery and weaker USD, and we prefer Asia ex-Japan stocks than EM stocks.

Neutral
Neutral
Short-term
overweight

Overweight

Long-term
Central & Eastern Europe and Latin America

Higher commodity prices may support EM stocks outside of Asia, but new virus variants and slow vaccine rollout remain key challenges.

Underweight
Underweight
Short-term
Neutral
Neutral
Long-term

Asian ex-Japan

Investment merits in Asia are attractive valuations and higher growth potential. We prefer China and Singapore.

overweight
Overweight
Short-term
overweight

Overweight

Long-term
China

A global leader in economic recovery with growth potential in manufacturing, consumption and investment from its NPC objectives and 14th 5-year plan, give us comfort to overweight Chinese stocks as a structural story.

overweight
Overweight
Short-term
overweight

Overweight

Long-term
India

Having contained COVID-19 challenges, India’s economic data is on a strong path to recovery and corporate earnings are likely to be upgraded. Some near-term challenges remain: fiscal constraints and debt sustainability. 

Neutral
Neutral
Short-term
overweight

Overweight

Long-term
Hong Kong

HK has a strong IPO pipeline and benefits from Chinese growth. Cyclical and financial sectors stand to benefit from reflation, but HK is exposed to uncertain global demand and trade outlook.

 Neutral
Neutral
Short-term
overweight
Overweight
Long-term
Singapore

Singapore can attract higher FDI as regional supply chains shift, and it stands to benefit from its cyclical sectors.

overweight
Overweight
Short-term
overweight

Overweight

Long-term
South Korea

As a RCEP beneficiary, South Korea is exposed to the structural tech story, semiconductor demand and global memory shortage. Whilst we remain positive on digital, valuations look full and we downgraded to Neutral.

Neutral
Neutral
Short-term
Neutral
Neutral
Long-term
Taiwan

Taiwan is a proxy to the global structural tech, semiconductors, 5G and stay-at-home trade. It stands to benefit from cyclical rotation but valuations are no longer cheap. We downgraded to Neutral for the long term. 

Neutral
Neutral
Short-term
Neutral
Neutral
Long-term

Developed markets (DM)

The surge in bond yields in a short space of time has limited further upside as it was primarily driven by inflationary concerns which are temporary in nature. Overall DM bonds returns are unattractive. 

Underweight
Underweight
Short-term
Underweight
Underweight
Long-term
United States

Reflationary forces have pushed US Treasury yields to new highs in a short space of time, which remain attractive relative to other government bond markets. We think risk-rewards are unattractive in the long term as a dovish Fed limits the risk of higher yields. 

Neutral
Neutral
Short-term
Underweight
Underweight
Long-term
United Kingdom

The BoE is accommodative and committed to its QE program, and gilt yields are attractive. 

overweight
Overweight
Short-term
Underweight
Underweight
Long-term
Eurozone

Although the ECB is committed to its monetary policy, European government bond valuations look unattractive.

Underweight
Underweight
Short-term
Underweight
Underweight
Long-term
Japan

Japanese Government bonds face limited policy room and risk-rewards are unattractive.

Underweight
Underweight
Short-term
Underweight
Underweight
Long-term
Emerging Markets (local currency)

We are constructive on EM bonds as higher yields and potential local currency appreciation would benefit this asset class.

overweight
Overweight
Short-term
overweight

Overweight

Long-term
Emerging Markets (Hard currency)

EM debt has not been significantly affected by the upward movement in US Treasury yields, which should continue to be supported by the search for carry and yield. 

overweight
Overweight
Short-term
 Underweight
Underweight
Long-term

Global investment grade (IG)

We are positive in the near-term as global IG bonds have a place in portfolio diversification. However spreads have come down notably and potential returns have become unattractive in the long run.

overweight
Overweight
Short-term
Underweight
Underweight
Long-term
USD investment grade (IG)

With government bond yields being low, IG bonds can act as an effective diversifier in a portfolio, but valuations are unattractive in the long term. 

overweight
Overweight
Short-term
Underweight
Underweight
Long-term
EUR and GBP investment grade (IG)

The ECB and BoE are committed to quantitative easing. Spreads are at historically tight levels and we need to monitor any deterioration in trends of corporate fundamentals. 

Neutral
Neutral
Short-term
Underweight
Underweight
Long-term
Asia investment grade (IG)

Asia IG is relatively more attractive than developed markets and USD weakness is a positive for corporates with USD-denominated debt. Asian economies are likely to lead in growth recovery. 

overweight
Overweight
Short-term
overweight

Overweight

Long-term
Global high-yield (HY)

Overweight in the short-term because HY should perform well during the recovery. Downgraded to Neutral in the long-term as the difference in yields between Treasuries and HY has narrowed, given the run-up in Treasuries. 

overweight
Overweight
Short-term
Neutral
Neutral
Long-term
US high-yield (HY)

We like US HY over 3-6 months because of its exposure to the recovery. However, the credit risk premium for owning US HY over government bonds has fallen, meaning longer-term investors may wish to reduce exposure.

overweight
Overweight
Short-term
Neutral
Neutral
Long-term
Europe high-yield (HY)

Europe HY valuations warrant a neutral position although the ECB is ultra-accommodative.

 Neutral
Neutral
Short-term
 Neutral
Neutral
Long-term
Asia high-yield (HY)

Default rates should remain low and spreads look attractive relative to other global opportunities.

overweight
Overweight
Short-term
overweight

Overweight

Long-term

Gold

Gold pulled back as the economy continues to recover, but low rates and low real yields will continue to support gold. There remains a place for gold in well-diversified portfolios during times of volatility. 

overweight
Overweight
Short-term
 Neutral
Neutral
Long-term
Oil

Supply and demand dynamics are improving for oil, but Brent and WTI prices remain vulnerable to oversupply in a pandemic world where re-opening of economies and vaccine administration may disappoint.

 Neutral
Neutral
Short-term
 Neutral
Neutral
Long-term

Sector Views

 

Global and regional sector views based on a 3-6 month horizon

We are positive on the consumer discretionary sector as it benefits from a low interest rate environment and pent-up demand from COVID lock-down measures. Consumer finance is cheap and readily available which spurs spending, plus household savings are at record levels. 

Global
Global
Overweight
US
US
Overweight
Europe
Europe
Overweight
Asia
Asia
Overweight

We recently added Financials to our list of preferred cyclical sectors that we like, led by the improvement in the economic cycle as financial institutions can benefit from more lending activities in a low interest rate environment. In addition, they can benefit from rising inflation and steeper yield curves. 

Global
Global
Overweight
US
US
Overweight
Europe
Europe
Overweight
Asia
Asia
Neutral

Economic data and business capital investment surveys continue to support an improvement in sentiment and our pivot deeper into cyclical exposure. A number of industrial stocks were sold off from the depth of the pandemic and are still trading at compelling valuations as their earnings and margins outlook recover. 

Global
Global
Overweight
US
US
Overweight
Europe
Europe
Overweight
Asia
Asia
Neutral

The tech sector is at the cusp of a structural super-cycle and a key beneficiary of the stay-at-home plays. The demand for technology ranges greatly from online education, shopping, gaming to tele-consulting, 5G, AI and more. Improving economic conditions support risk assets.  

Global
Global
Overweight
US
US
Overweight
Europe
Europe
Overweight
Asia
Asia
Overweight

The sector benefits from steady cash flows and growth from increased data usage as businesses and households moved online. The ongoing roll-out of 5G is likely to provide support for telecom equipment providers and enablers. Media companies are likely to see continued robust demand but social media companies may face heightened regulatory headwinds.

Global
Global
Overweight
US
US
Overweight
Europe
Europe
Neutral
Asia
Asia
Overweight

We believe that the cyclical materials sector is consistent to our risk-on approach and overweight to equities. Materials could benefit from higher construction demand provided by the infrastructure stimulus bills across different countries.

Global
Global
Overweight
US
US
Overweight
Europe
Europe
Overweight
Asia
Asia
Overweight

The sector’s high dividend yield is attractive, and valuations tend to be supported by a low yield environment. However, there could be dispersion in performance, for example, the growth of the online economy which might have a significant impact on commercial real estate.

Global
Global
Neutral
US
US
Neutral
Europe
Europe
Underweight
Asia
Asia
Overweight

The sector faces headwinds as investors may reduce defensive sector allocation in exchange for a cyclical sector bias with the improvement of economic data. Year-on-year comparison would not be favourable due to panic buying and stock piling of consumer essentials in 1Q and 2Q 2020.

Global
Global
Underweight
US
US
Underweight
Europe
Europe
Underweight
Asia
Asia
Underweight

Traditional fossil-fuels supply curbs by OPEC+ has supported prices and demand may continue to improve with the gradual re-opening of the global economy in 2H2021. We expect some volatility in energy stocks as clean-energy initiatives and ESG measures continue to be in focus. 

Global
Global
Neutral
US
US
Neutral
Europe
Europe
Neutral
Asia
Asia
Neutral

With the successful roll-out of mass vaccination, concerns will likely turn to drug pricing later in 2021 with the new US administration, which may cause volatility in the sector. Medical technology and biotechnology companies are likely to see strong demand as healthcare and technology grow in tandem in the pandemic-era.

Global
Global
Neutral
US
US
Neutral
Europe
Europe
Neutral
Asia
Asia

Overweight

The utilities sectors tend to underperform when the markets are risk-on. There has been an increasing pivot towards a more cyclical bias and cheaper sectors by investors which undermines utilities’ performance, especially following optimism around carbon-neutral targets. 

Global
Global
Underweight
US
US
Underweight
Europe
Europe
Neutral
Asia
Asia
Underweight

 

⬆“Overweight” implies a positive tilt towards the asset class, within the context of a well-diversified, typically multi-asset portfolio.

⬇“Underweight” implies a negative tilt towards the asset class, within the context of a well-diversified, typically multi-asset portfolio.

➡“Neutral” implies neither a particularly negative nor a positive tilt towards the asset class, within the context of a well-diversified, typically multi-asset portfolio.

View on this asset class has been upgraded

View on this asset class has been downgraded

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