The effective COVID-19 vaccine rollout has proved instrumental for governments to lift restrictions and gradually reopen economies over the past months. Despite the resurgence of COVID-19 cases, driven by the spread of the Delta variant, hospitalisation rates remain low compared to previous waves.
On this basis, the economic reopening should continue across the major developed economies through the second half of 2021. It also implies that the focus for markets has shifted to the strength of the growth rebound, the implications for inflation, and the timing of central bank moves to taper asset purchases and eventually raise interest rates.
Given the ongoing economic recovery, major economies’ inflation rates are expected to show some normalisation in 2021, though likely only reaching 2.0 per cent in the US and 1.0 per cent in the eurozone, the latter being significantly below the target of the European Central Bank (ECB). However, central banks’ potential tolerance for higher inflation should help stabilise and lift long-term inflation expectations, eventually exceeding recent historical averages.
Inflation-linked bonds, which provide compensation for rising inflation, would benefit from the rise in inflation expectations, unlike traditional fixed-rate bonds. When adjusted for duration differences, inflation-linked bonds offer a better return prospect than respective nominal government bonds.
On the credit side, central banks and governments globally are expected to retain the very supportive monetary and fiscal policies, especially the credit facility to purchase investment-grade corporate bonds directly, which should support further spread tightening in the new year. High- quality corporate bonds are expected to offer a better return over nominal government bonds, due to continued strong central bank support, not only in Europe but also in the US.
Despite the Delta-driven rise in stock market volatility, equity markets are expected to continue to trade higher in the second half of the year. The overall growth concerns, triggered by the spread of the Delta variant, are expected to gradually diminish as economies continue to reopen and consumer confidence returns. In this regard, cyclical sectors are expected to remain in favour and to continue to perform well as economies rebound and return to growth.
With valuations at historic highs, earnings growth momentum is expected to drive the next stage of the economic cycle. The reversal in earnings expectations follows the aggressive rate at which expectations were downgraded at the start of COVID-19 and mirrors the upgrades across the macroeconomic growth outlook over the past few months.
Despite the Delta-driven rise in stock market volatility, equity markets are expected to continue to trade higher in the second half of the year
Going forward, growth in earnings expectations is expected to continue, supported by the return of consumer confidence, an elevated savings rate and pent-up demand, particularly for the hardest hit sectors, such as travel and entertainment.
In the downside risk scenario, where the resurgence in COVID-19 cases continues to pick up, the negative impact on the global economic growth is expected to be of a lesser extent than previous waves.
In the local market, Malta’s strong fiscal package response and the economic reopening over summer is expected to drive a rebound in economic growth, particularly across the tourism industry. On the other hand, the resurgence of COVID-19 cases, combined with a possibility of a prolonged placement in the FATF grey list, could adversely affect financial institutions and foreign direct investments.
In the Malta Government Stock market, the expected economic recovery was already reflected with the rise in yields and yield-curve steepening. Following the FATF greylisting announcement, the impact on MGSs is not expected to be material, given the expected rebound and that most of the local sovereign debt is owned by local investors.
On the other hand, both the local corporate bond and the equity market are expected to gain from this improving outlook. The corporate bond market, which did not record any defaults, is expected to continue to benefit from its exposure to the property and tourism industries as the economy rebounds.
Similarly, given the cyclical nature, the Maltese equity market should benefit from the reopening of economies, the gradual return to tourism and vaccination rates increasing globally.
The writer and the company have obtained the information contained in this article from sources they believe to be reliable, but they have not independently verified the information and therefore its accuracy cannot be guaranteed. The writer and the company make no guarantees, representations or warranties and accept no responsibility or liability as to the accuracy or completeness of the information. They have no obligation to update, modify or amend this article or to otherwise notify a reader thereof in the event that any matter stated therein, or any opinion, projection, forecast or estimate set for the herein changes or subsequently becomes inaccurate. BOV Asset Management Ltd is licensed to conduct investment services in Malta by the Malta Financial Services Authority.
Rachel Meilak, portfolio manager at BOV Asset Management Ltd.