The Delta variant appears to have given COVID-19 a new lease of life. Just as the developed world was set to relax restrictions, new infections have surged. Rising cases present a dilemma for policymakers with renewed pressure on healthcare infrastructure. The delta variant is 60% more transmissible than the Alpha or Kent variant and is twice as likely to need hospitalisation. Delta is moderately resistant to vaccines, particularly in people who have received just one dose. The good news however is that two doses of the Pfizer vaccine, prevents symptoms in 88% of those vaccinated. This silver lining is why we remain steadfast in our optimism. We expect an economic and corporate profit recovery to persist which supports risk assets.
Concerns around the delta variant exacerbated market unease after the Federal Reserve’s June meeting. The Fed has hinted at an earlier start to policy tightening and bond markets have rallied significantly. The July meeting was unremarkable in its impact on markets but highlighted the data dependency of monetary policy. The Fed Chair, Jerome Powell, like a disgruntled parent on a car trip reminded us that the US economy is not where he feels it appropriate to start withdrawing policy support. The Fed maintained its bond buying programme and left interest rates unchanged. Inflation hawks within the Fed appear to have forgotten the asymmetry of risks this early in an economic cycle. The Jackson Hole symposium on monetary policy will help give markets further colour on the Fed’s approach post crisis.
We have spent that last six months talking about the revival of corporate earnings. Two thirds of US companies have now reported corporate profits for the second quarter. Aggregate earnings are up 85% year on year which is the fastest pace of profits growth since Q4 2009. 88% of companies have exceeded analyst estimates with cyclicals; energy, materials and consumer discretionary companies showing the largest profit gains.
In the UK, banks such as Lloyds, Barclays and HSBC produced better results and reinstated their dividends. Upside was driven by lower loan loss provisions and improving loan demand. Energy giants Royal Dutch and BP produced strong results. Both companies upped their dividends and reinstated share buybacks. The highly cyclical UK equity market is expected to show the largest recovery in profits in 2021. European brands such as LVMH and Kering (the owner of Gucci) produced robust results as they capitalised on a strong demand for luxury products. European banks like their UK peers have shown a large recovery in profits and are set to reintroduce dividends.
Chinese authorities set off alarm bells in financial markets by clamping down foreign listed Chinese companies. Didi, a popular ride hailing company, has seen its stock price halve after its June IPO. The Chinese government has prevented business as usual for the company until it fixes data safety issues. Chinese regulators also announced restriction on for-profit tutoring companies which severely limits on their ability to grow and raise new capital. Stocks in the sector fell by 50% and are unlikely to recover. The spectre of an increasingly assertive Chinese government raises risk for investors and is likely to weigh on multiples.
Our pro-cyclical stance has been tested over the summer months, with portfolios giving back some of their year-to-date gains versus benchmarks. We continue to view the economic recovery as early cycle which causes us to favour risk assets. We expect the recovery to become self-sustaining driven by a strong recovery in corporate profits, employment growth and policy support. We continue to monitor markets for meaningful risks to our view and are prepared to adjust are optimism if things change.
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