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Five insights in five minutes

Five in Five: oil, bonds, China inflation, equity transitions, Korea
04 June 2021

    Black gold

    Five in Five has listened to oil experts for a quarter of a century. Millions of barrels this, backwardation that, cold northern winters here, Nigerian pipelines there...And then along comes yet another 50 per cent move in prices that absolutely no one predicted. So when the biggest financial news this week is an Opec meeting and Brent pushing through $70 for the first time since October 2018, why should we care? The typical answer is that higher oil prices are inflationary and could push up interest rates, which is bad for equity and fixed income returns. But energy now accounts for just six per cent of the US consumer inflation basket and a tenth of Europe’s. Nor does there seem to be a long-term relationship between oil prices and stock and bond market performance. As can be seen in the chart below, the MSCI World index and ten-year treasuries rose with the black stuff from 1990 to 2010. Over the past decade, however, shares and bonds have kept rising while oil trended the opposite way. Investors are advised to focus their attention elsewhere.

    Themes: commodities, fixed income, equities

    Black gold 

    Listless treasuries

    A breather? Calm before the storm? Or has the Federal Reserve fluked a soft landing worthy of Anna Pavlova? Apologies for mixing metaphors, but these are just some of the phrases we’ve heard to describe the sideways trading in ten-year treasuries of late. Compared with a tripling since August, yields on the benchmark US government bond have moved in a narrow 18 basis point range for the past three months. While volatility may be quiet, not so the myriad opinions on where treasuries are heading next. Who to listen to? Our strategists for a start, who focus on the fundamentals. As they make clear in the chart below, two per cent on ten-year treasuries is about the equilibrium level based on historical appetites for taking interest rate risk. Or you could just follow the money. We’ve analysed the futures market, for example, and there are two and a half times more open put option contracts than calls, suggesting that investors fear a sell-off ahead of declining yields. But this could also mean that near-term inflation worries are priced in – capping further bond price rises.

    Themes: fixed income, global equities, emerging markets

    Listless treasuries 

    China’s inflation scare

    The past year has reminded us that we live in a world of global contagions. One of the most prevalent at the moment is inflation fear-mongering, which has seen a big surge in China this week. The country reported a 6.8 per cent reading for producer price inflation in April. Many investors are worried and demand answers: Will PPI inflation spill over to consumer price inflation? Could rising prices then stifle equity performance? The chart below suggests a ‘no’ to both questions. With a negative correlation of minus 0.3 over the past five years, CPI and PPI have in fact gone their separate ways more so than not. What is more, it doesn’t seem that changes in price levels have any bearing on the direction of onshore stocks, which in the most recent half decade had correlations of minus 0.2 and minus 0.1 with PPI and CPI, respectively. To further ease investors’ minds, the main causes of this most recent spike in PPI – a low base versus last year and a Covid-strained supply chain – are not here to stay.

    Themes: China, macro

    China’s inflation scare 

    Equity transitions

    It is often hard to see the wood for the trees when it comes to equities. Globally, there are about 100,000 primary securities across 100 exchanges, worth in total more than $100 trillion. (At least those numbers are easy to remember!) So let’s focus instead on the world’s top 50 companies – still a quarter of total market cap – in order to understand some key trends over the past thirty years. First thing to notice is that Thomas Picketty is onto something with his famous theory that capital outpaces growth. Net profits at these biggest listed firms were 0.3 per cent of global output in 1990; three decades later they are one per cent. Meanwhile, the top 50’s market cap quintupled to 25 per cent of output. The next obvious trend is the rise of mega tech. Over the same period technology stocks have gone from a count of three to 21 – including eight in the top ten. China also stands out: from zero to eight names in the top 50. Most encouragingly, perhaps, is how well the equity woods support new life. At the end of each decade, new names comprise half the list, as per the chart below.

    Themes: global equities, China equities

    Equity transitions 

    South Korea

    Exports have been paving the road to recovery in South Korea, increasing nearly 50 per cent from last year’s drop – the country’s biggest export surge in over three decades. This has played a part in stronger-than-expected economic growth in the first quarter and the Bank of Korea’s upward revision this year from three to four per cent. It’s no wonder that consumer confidence for the country was at its highest in three years this May. With almost half of the MSCI Korea Index allocated to information technology – followed by a tenth each in materials and consumer discretionary – South Korea should benefit from any cyclical global recovery. Sure, there are growth stocks vulnerable to higher bond yields. But do not forget that South Korea’s forward price-to-earnings ratio is 12 times versus 20 times for the MSCI All Country World Index. It’s price-to-book ratio is half of MSCI ACWI’s too. And as can be seen in the chart, both metrics for Korea are lower than those of broader emerging markets, despite outperformance this year.

    Themes: South Korea equities

    South Korea 


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