The big questions for equities
CIO MONTHLY | JULY 2021
The investing environment, while still broadly positive, is perhaps more difficult now than it has been since the pandemic began. The challenge for investors is that although we continue to believe equities can grind higher over 2021, there will likely be a considerable degree of ‘rotation’ within sectors, coupled with bouts of volatility.
- Will inflation be persistent or transitory? Currently, the biggest driver of markets is the outlook for inflation and the next few months will likely be dominated by elevated inflation. For now, the bond market seems to be suggesting that inflationary pressures will be transitory. If, as we expect, inflation pressures are short-lived, there will be ramifications for how portfolios need to be positioned, as an environment of slower growth and inflation peaking may challenge the reopening trade and other cyclical recovery plays.
- How much of a headwind will tapering be to equity markets? Looking back at the 2013 tapering episode, developed market equities weathered the process well post the small initial wobble. In terms of sector leadership, there were three distinct phases. Firstly, before the tapering announcement, market performance was favouring a marginal tilt towards cyclicals over defensives. Secondly, after the announcement until tapering was implemented, cyclicals performed very strongly versus defensives. Thirdly, in the six to 12 months after tapering started, leadership turned more defensive, with cyclicals lagging, as did value versus growth.
- Can earnings momentum support equities higher? With interest rate risks combining with elevated valuations, EPS growth is a key factor that investors should keep in mind when constructing equity portfolios. If EPS momentum can be sustained, it will provide an important buffer against headwinds for valuation multiples. It is the combination of yield and EPS momentum that might, in a relative sense, insulate Australian performance versus the rest of the world.