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Goldman leads Wall Street bulls as markets ride high



Goldman Sachs is the most bullish bank on Wall Street. That is notable in itself — for good or ill, the US investment bank’s views carry a good deal of weight with large investors and hedge funds.

But it is also useful to look at why some investors are reluctant to share in this enthusiasm just yet.

In its outlook for the year ahead — a tradition that banks have bravely stuck with despite the painfully short shelf life of the 2020 vintage — Goldman said it believed the US S&P 500 equity index would stretch as high as 4,300 by the end of next year. That would be a near 20 per cent rally from current levels.

The bank has stuck its neck out a little here with what it calls its “Roaring 20s Redux” view. The consensus among its competitors is closer to 3,800, just 5 per cent or so above where we are today. Some see barely any upside for the world’s pre-eminent barometer of investor sentiment in the coming 12 months, predicting instead that tech stocks will gradually surrender their leading spot in the index to hundreds of more cyclical names. 

Still, it is easy to see where Goldman Sachs is coming from with its ebullient view. Indeed, the bank said in a later note that some of its clients balked at the 4,300 target, arguing it should be even higher.

Right now, those bulls are in control. On Tuesday, the Dow Jones Industrial Average crossed 30,000 for the first time — a number Donald Trump claimed was “sacred”. The more widely watched S&P, meanwhile, closed at a record high, led by energy and financials — sectors that are catching up at the end of a grim 2020. US small-cap stocks are enjoying their best month in at least two decades. European bank stocks have not yet shaken off the blow from March, but they are also staging their biggest comeback in decades.

In those pockets of the markets, the mood is almost giddy. News that former Fed chair Janet Yellen is likely to be the next US Treasury secretary, and baby steps towards Donald Trump formally conceding the US election to Joe Biden have helped this along, backed by central banks that have promised not to spoil the party. Together, those factors have “sent risk sentiment into overdrive”, said Kit Juckes, a macro strategist at Société Générale in London.

But it is news of potential vaccines to bring an end to the coronavirus pandemic that has significantly brightened the outlook, breaking 2020’s curse of seemingly endless uncertainty.

“A few weeks ago, it felt like this could go on for ever,” said Mike Bell, global market strategist at JPMorgan Asset Management. “It felt like it could be another 100 years. The vaccines are a game-changer. When the facts change, you change your mind.”

At the very least, 2021 simply cannot be worse. Barring a meteor strike, it is hard to imagine that the coming year could deliver the same kind of disruption. 

But some fund managers are still not swept up in the euphoria. In addition to the pushback from Goldman Sachs’ clients arguing the bank was being too cautious, some felt it was too bullish, unnerved by the potential for rising inflation expectations to push up government bond yields and in turn chip away at equities.

It is hard to discern signals from bonds, which central banks are buying in huge volumes. But David Riley, chief investment strategist at BlueBay Asset Management in London — himself an optimist for next year — pointed to the lack of a forceful drop in price of US government bond prices since the vaccine news broke as a clue that big investors may be holding fire from the “back to normal life” trade for now. Ten and 30-year US yields have not meaningfully picked up.

“The market does not have full conviction yet, or we would have higher long-term yields,” Mr Riley said. “Either you think bond markets behave differently now, or you are trying to have your cake and eat it. You think there’s a global recovery back to pre-Covid levels, you think unemployment goes back to where it was before, but you still think we have ultra-low interest rates — the perfect cocktail.”

This is where the real debate for 2021 lies. If vaccines really are the silver bullet to end the pandemic crisis quickly, the danger (a nice problem to have, to be clear) is that support from the bond market ebbs away. Some may also call into question the need for further monetary and fiscal support.

This is not top of the agenda today. But investors worry that if the vaccines really do take us back to life as we knew it in 2019, the potential for a return of long-lost inflation and higher bond yields will hold back stock markets’ animal spirits.

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Pimco’s Ivascyn warns of inflationary pressure from rising rents




US Inflation updates

A leading US bond manager has warned of inflationary pressure from housing rental costs that could push interest rates higher and overturn a sense of complacency among investors.

The comments by Dan Ivascyn, chief investment officer at Pimco, which has $2.2tn under management, comes after US 10-year interest rates eased in recent months to about 1.25 per cent. Fears of an inflation surge sparked alarm among bond investors at the start of the year and pushed the important benchmark to a peak of 1.75 per cent by the end of March.

“There is a lot of uncertainty on inflation and while our base case is that it proves transitory, we are watching the relationship between home prices and rents,” Ivascyn told the Financial Times. “There may be more sustained inflation pressure from the rental side.”

Owners’ equivalent rent is a key input used for calculating the US consumer price index. As rents become more expensive, investors could become increasingly concerned about “sticky inflation”, pushing the 10-year Treasury yield back towards 1.75 per cent, said Ivascyn. 

Line chart of US 10-year expected rate of inflation showing long-term bond market inflation expectations loiter near decade peaks

The Federal Reserve said in its latest policy statement last week that it had made “progress” towards its goals of full employment and 2 per cent average inflation. Jay Powell, the Fed’s chair, said there was more “upside risk” to the inflation outlook, although he expressed confidence in transitory price pressure over time.

The latest measure of core consumer prices, which is followed by the central bank, ran at 3.5 per cent over the 12 months to June, the fastest pace since July 1991.

“There is a lot of noise and uncertainty in the data” and “the Fed has a difficult job deciphering the economic information coming in”, said Ivascyn.

The fund manager said the potential for much higher bond yields is probably capped by the prospect of the central bank tightening policy in the event of inflation expectations breaking higher.

Bar chart of assets under management ($bn) showing Pimco Income ranks as the largest actively managed bond fund

“We do believe if the Fed sees inflation expectations rise out of their comfort zone, that they will probably act,” said Ivascyn. “That has been the message from Powell’s last two press conferences.”

Pimco expects the central bank will announce a tapering of its current $120bn monthly bond purchases later this year, with a view to starting the process in January. While the policy shift is being “well telegraphed” and data dependent, Ivascyn said higher bond yields and more market volatility were likely.

“This is a tough market environment and it is a time when you want to be careful,” he said, adding that Pimco had been reducing its exposure to interest rate risk as the bond market had pulled borrowing costs lower. 

“Valuations are stretched and it makes sense to adjust our portfolios.”

Ivascyn oversees the world’s largest actively managed bond fund, according to Morningstar. The $140bn Pimco Income Fund co-managed with Alfred Murata, has a total return of 2 per cent this year, versus a slight decline in the Bloomberg Barclays US Aggregate index. Over the past year, the fund has extended its long record of beating its benchmark, according to Morningstar.

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Wall Street stocks follow European and Asian bourses lower




Equities updates

Wall Street stocks followed European and Asian bourses lower on Friday after markets were buffeted this week by jitters over slowing global growth and Beijing’s regulatory crackdown on tech businesses.

The S&P 500 closed down 0.5 per cent, although the blue-chip index still notched its sixth consecutive month of gains, boosted by strong corporate earnings and record-low interest rates.

The tech-focused Nasdaq Composite slid 0.7 per cent, after the quarterly results of online bellwether Amazon missed analysts’ forecasts. The tech conglomerate’s stock finished the day 7.6 per cent lower, its biggest one-day drop since May 2020.

According to Scott Ruesterholz, portfolio manager at Insight Investment, companies which saw significant growth during the pandemic may see shifts in revenue as consumers move away from online to in-person services.

“[Consumers are] going to start spending more on services, and so those businesses and industries which have benefited in the last year, companies like Amazon, will be talking about decelerating sales growth for several quarters,” Ruesterholz said.

The sell-off on Wall Street comes after the continent-wide Stoxx Europe 600 index ended the session 0.5 per cent lower, having hit a high a day earlier, lifted by a bumper crop of upbeat earnings results.

For the second quarter, companies on the Stoxx 600 have reported earnings per share growth of 159 per cent year on year, according to Citigroup. Those on the S&P 500 have increased profits by 97 per cent.

But “this is likely the top”, said Arun Sai, senior multi-asset strategist at Pictet, referring to the pace of earnings increases after economic activity rebounded from the pandemic-triggered contractions last year. Financial markets, he said, “have formed a narrative of peak economic growth and peak momentum”.

Column chart of S&P 500 index, monthly % change showing Wall Street stocks rise for six consecutive months

Data released on Thursday showed the US economy grew at a weaker than expected annualised rate of 6.5 per cent in the three months to June, as labour shortages and supply chain disruptions caused by coronavirus persisted.

Meanwhile, China’s regulatory assault on large tech businesses has sparked fears of a broader crackdown on privately owned companies.

“It underlines the leadership’s ambivalence towards markets,” said Julian Evans-Pritchard of Capital Economics. “We think this will take a toll on economic growth over the medium term.”

Hong Kong’s Hang Seng index closed 1.4 per cent down on Friday, while mainland China’s CSI 300 dropped 0.8 per cent, after precipitous slides earlier in the week moderated.

Japan’s Topix closed 1.4 per cent lower, after the daily tally of Covid cases in Tokyo surpassed 3,000 for three consecutive days. South Korea’s Kospi 200 dropped 1.2 per cent.

The more cautious investor mood on Friday spurred a modest rally in safe haven assets such as US government debt, which took the yield on the 10-year Treasury, which moves inversely to its price, down 0.04 percentage points to 1.23 per cent.

The Federal Reserve, which has bought about $120bn of bonds each month throughout the pandemic to pin down borrowing costs for households and businesses, said this week that the economy was making “progress” but it remained too early to tighten monetary policy.

“Tapering [of the bond purchases] could be delayed, which in many ways is not bad news for the market,” said Anthony Collard, head of investments for the UK and Ireland at JPMorgan Private Bank.

The dollar, also considered a haven in times of stress, climbed 0.3 per cent against a basket of leading currencies.

Brent crude, the global oil benchmark, rose 0.4 per cent to $76.33 a barrel.

Unhedged — Markets, finance and strong opinion

Robert Armstrong dissects the most important market trends and discusses how Wall Street’s best minds respond to them. Sign up here to get the newsletter sent straight to your inbox every weekday

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US regulators launch crackdown on Chinese listings




US financial regulation updates

China-based companies will have to disclose more about their structure and contacts with the Chinese government before listing in the US, the Securities and Exchange Commission said on Friday.

Gary Gensler, the chair of the US corporate and markets regulator, has asked staff to ensure greater transparency from Chinese companies following the controversy surrounding the public offering by the Chinese ride-hailing group Didi Chuxing.

“I have asked staff to seek certain disclosures from offshore issuers associated with China-based operating companies before their registration statements will be declared effective,” Gensler said in a statement.

He added: “I believe these changes will enhance the overall quality of disclosure in registration statements of offshore issuers that have affiliations with China-based operating companies.”

The SEC’s new rules were triggered by Beijing’s announcement earlier this month that it would tighten restrictions on overseas listings, including stricter rules on what happens to the data held by those companies.

The Chinese internet regulator specifically accused Didi, which had raised $4bn with a New York flotation just days earlier, of violating personal data laws, and ordered for its app to be removed from the Chinese app store.

Beijing’s crackdown spooked US investors, sending the company’s shares tumbling almost 50 per cent in recent weeks. They have rallied slightly in the past week, however, jumping 15 per cent in the past two days based on reports that the company is considering going private again just weeks after listing.

The controversy has prompted questions over whether Didi had told investors enough either about the regulatory risks it faced in China, and specifically about its frequent contacts with Chinese regulators in the run-up to the New York offering.

Several US law firms have now filed class action lawsuits against the company on behalf of shareholders, while two members of the Senate banking committee have called for the SEC to investigate the company.

The SEC has not said whether it is undertaking an investigation or intends to do so. However, its new rules unveiled on Friday would require companies to be clearer about the way in which their offerings are structured. Many China-based companies, including Didi, avoid Chinese restrictions on foreign listings by selling their shares via an offshore shell company.

Gensler said on Friday such companies should clearly distinguish what the shell company does from what the China-based operating company does, as well as the exact financial relationship between the two.

“I worry that average investors may not realise that they hold stock in a shell company rather than a China-based operating company,” he said.

He added that companies should say whether they had received or were denied permission from Chinese authorities to list in the US, including whether any initial approval had then be rescinded.

And they will also have to spell out that they could be delisted if they do not allow the US Public Companies Accounting Oversight Board to inspect their accountants three years after listing.

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