Plenty of good news for the hotel sector, Irish housing completions close in on pre pandemic levels and the US Fed acknowledges it may taper bond purchases sooner rather than later. All these stories and more are covered in this week’s insights update from BlackBee.
Last week saw central bankers continue to lay the groundwork for a reversal of their emergency monetary policies prompted by the coronavirus pandemic. In a speech the US Fed vice chair Richard Clarida commented that the economy had made progress towards the Fed’s goals that would warrant changes to its policies, adding that he would support a rate hike in 2023. In the UK the Bank of England appeared to go one step further, warnings that “some modest tightening of monetary policy is likely to be necessary” over the next couple of years in order to counter the risk of persistently rising inflation rates.
Markets shrugged off these comments, suggesting that they’re broadly comfortable around a consensus of rates beginning to move higher from 2023 onwards. However, as we mentioned in last week’s update, the slackening monetary policy tailwind from now on really means further gains for risk assets (equities, credit and commodities) will fall squarely on the shoulders of the outlook for the economy and market fundamentals such as corporate profits/cash flows (for equities, credit) and occupier demand and rent inflation (for real estate).
In terms of global economic data, the overall picture remained positive last week. July’s ISM manufacturing and service sector readings in the US remained indicative of strong US economic growth, particularly in the service sector which is so important to the economy there. The July employment report (943,000 jobs were created versus expectations of around 870,000) also showed the US economy to be in fine fettle. Last week’s Purchasing Manager Index (PMI) data also revealed that the Irish economy is roaring back to life as it leaves the COVID pandemic behind. Both manufacturing and service sector PMI readings were well above 60 in July, indicating strong month on month growth for both sectors. In fact, the service sector PMI at 66.6 was the highest print in over 20 years, helped by people unleashing their pent up demand via spending as society reopened.
Equity markets gave up some ground last week despite continued good news on second quarter earnings. Data from Refinitiv showed that Q2 profits at US companies were up 86% compared to a year earlier while revenues were up 21%. Equity markets in many markets pushed to fresh all-time highs last week with many investors focusing on the July US employment report (noted above) which certainly helped bullish sentiment towards stocks. On the earnings front the broad picture remained a positive one – with around 80% of S&P 500 companies having reported Q2 earnings, a whopping 86% of them beat analysts’ expectations. Across the sectors, sentiment towards technology recovered following the bumps the previous week arising from China’s intervention into the education sector which hit regional technology companies hard.
Last week saw a continuation of the recent rally in government bond markets in particular. In our view there’s a few reasons for the rally – risks around a COVID resurgence as a result of the delta variant are one reason. Economic data has also been slightly weaker than expected in the past couple of months. In our view this isn’t a risk for the global economic recovery, but it has helped push real bond yields lower (nominal bond yields with inflation stripped out) and helped bond prices push higher. Irrespective of their recent performance, we believe government bonds in particular offer very little return to long term investors right now and this is going to be a problem in producing returns in the future. Our chart of the week shows that over €16 Trillion of bonds around the world (around 25% of the total bond market) are now offering negative yields i.e. bond investors are ‘paying’ governments and many corporates to borrow from them…hardly a formula for successful investing!
Commodity markets gave up some ground last week, spooked by what a COVID resurgence (thanks to the delta variant) could do to demand. Oil was the biggest casualty as rising COVID case numbers in parts of the world and some air travel restriction announcements in Asia hurting prices. Copper also struggled however, given its role as a key input into manufactured goods across the world economy.
Forestry – CIF Highlights upward pressure licencing backlogs on housing construction costs
In our recent sector update on forestry we discussed the growing backlog of forestry licences yet to be issued for afforestation and felling, noting that this represents a major hurdle to both Ireland meeting its afforestation targets and to the forestry industry in the country. However, the Construction Industry Federation (CIF) also last week flagged another consequence of this backlog – lack of timber availability which is in turn causing housing construction costs to rise further, potentially putting some projects in jeopardy. The CIF noted that the average cost of constructing a home has risen by €15,000 as a result of rising timber costs, something that has been exacerbated by Ireland’s need to import large volumes of timber which can’t be sourced domestically because of delays in issuing felling licences. At a time when more housing is badly needed, this really underlines the need to eliminate licensing backlogs as quickly as possible.
Commercial Real Estate – 87% of workers say office is still needed
Although the coronavirus pandemic has altered work practices, most real estate commentators have come around to the idea that the office will still represent a central part of working life post pandemic. It also seems that workers are generally in agreement with this, based on the results of Savills’ Office FiT 2021 survey that were released last week. Overall, 87% of workers in the Europe, Middle East and Asia (EMEA) region answered that the office was still necessary for working life with the response rate from Ireland one of the highest in that region. So as the economy reopens and occupier demand begins its recovery it seems clear that work life, although probably changed by the pandemic, will still revolve around the office.