The US market recorded only a modest gain of 0.7%, however the technology sector continued to underperform with the NASDAQ declining 1.5%. President Biden unveiled some ambitious spending programs totalling a US $6 trillion which equates to a staggering 30% of GDP. Given the very slim majority the Democrats enjoy in the House and a 50/50 tied Senate, it will be very difficult for this level of spending to pass through both Houses of Congress especially as moderate Senate Democrats have voiced concerns.
Elsewhere, European markets were quite strong with Germany up 2.5%, France up 3.4% while the UK improved only marginally by 0.7%. Bond markets were remarkably subdued during the month shaking off the inflation fears that prompted a spike in yields during February with 10-year bonds in Australia consolidating around 1.65%, well below the February highs.
In currency markets the Australian dollar traded in a fairly narrow range finishing the month relatively unchanged at 77.3 US cents. Australian residential house prices continued to surge with the median house price in Sydney improving by 3.0% during May and most capital cities posting impressive gains. The positive wealth effect of this, together with improving employment, bodes well for discretionary spending going forward.
Earnings revisions will be positive for share markets
When analysts positively revise their expectation for company earnings, it is usually good news for share markets. In Australia, company earnings in May were positively revised for the ninth consecutive month, something that hasn’t been achieved for the past 20 years. With interest rates likely to be anchored at very low levels for some time, earnings revisions will be the major driver of share market returns in coming months. Let’s not forget that the global recession of 2020 was artificially induced by government policies designed to suppress the spread of COVID-19 so it stands to reason that economic growth will recover once restrictions are progressively removed. Our position has always been that the reopening of the global economy would lead to a broad-based recovery in corporate profits, including COVID laggard companies. Of some concern, however, is that many western governments are taking advantage of a relative indifference towards government spending and deficits to introduce massive fiscal spending programmes largely for political purposes. In our opinion, this level of stimulus is simply not necessary as the global economy will recover organically as it is progressively reopened. We have some concern that this is sowing the seeds for financial stress in future years as the cost of servicing this huge stock of government debt will only increase once interest rates eventually rise.
We are comfortable with the positioning of our multi-asset portfolios in the current environment. Late last year we took the opportunity to increase the weighting to equities on the basis that the rollout of the newly developed vaccines would facilitate a faster reopening of the global economy with a consequent improvement in corporate profits and share prices. Over the past six months, this strategy has played out successfully as equities have delivered solid returns so far this year. With short-term interest rates anchored at low levels for some time, we remain confident that equity markets will deliver sound returns for the foreseeable future. Cognisant of the longer-term risk of inflation, we also replaced the exposure to conventional Government bonds with inflation-linked bonds to protect against capital erosion and provide downside protection.