Huge central bank money printing – aka quantitative easing – and the pent-up spending power of consumers amidst the pandemic has prompted market players to expect a rise in inflation. Against that background, how should investors adjust portfolios?

With investors and former senior policymakers fretting about inflation, conditions are set fair for further gains to equities but portfolio managers should rotate holdings to capture a more broad-based market gain, according to Standard Chartered.

“The market narrative is shifting towards questions about ‘too much’ stimulus and a risk of inflation. We see this environment as supportive of a broadening equity market rally, albeit with significant rotations across sectors, regions and themes,” the wealth management office of the UK-listed bank said in a note. 

Huge central bank money printing – aka quantitative easing – and the pent-up spending power of consumers amidst the pandemic has prompted market players to expect a rise in inflation. This has also to some extent been reflected in rising bond yields. Former US Treasury Secretary Lawrence Summers said last Friday (Bloomberg) that the US risks rising inflation. “The idea that it can’t ratchet up quickly is just plain wrong,” Summers said. 

Standard Chartered said that there is potential for investors to rotate into value equities and to reduce exposure to the kind of tech stocks that have boomed during lockdowns.

On a regional basis, the bank said it prefers to hold equities from the US, Japan and Asia ex-Japan.

“The US is likely to benefit from what is turning out to be significant fiscal stimulus, a supportive Fed and a faster-than-expected COVID-19 vaccination process. Japan has benefitted from recent JPY [yen] weakness. A sustained improvement in earnings estimates and the market’s value-style characteristics are likely to be supportive. Asia ex-Japan should additionally benefit from long-term USD [dollar] weakness,” it said.

Standard Chartered has upgraded the UK to a “preferred region.”

“While a stronger GBP [sterling] could work against overseas earnings, we believe inexpensive valuations and earnings support from rising commodity prices are likely to more than offset this headwind. We reduce euro area equities to least preferred. While the ECB [European Central Bank] has announced increased bond purchases, the region’s slow vaccination process risks delaying the growth and earnings recovery,” it said. 

Rotate
The bank said a rotation to value-style sectors has further to run. In the US, the bank is making two changes as a result: It is raising energy to a “preferred” sector, alongside its existing preference for materials, financials and industrials, supported by its modestly bullish view on oil prices as global demand recovers. Secondly, the bank has cut the US technology sector to a “core” holding. “The sector has high sensitivity to the risk of higher US Treasury yields. While we remain bullish on the sector, there is a risk that it underperforms the broader market if yields rise further,” Standard Chartered said.

Standard Chartered said that the rising US 10-year government bond yield has been “one illustration of this ‘worry rotation’.”

“In the short term, this could test the Fed’s tolerance limit. In equities, the rotation has played out through the outperformance of value vs growth stocks. With the Fed committed to staying on hold amid this backdrop, we view this rotation as positive for risk assets and continue to favour equities over bonds and cash,” it said. 

China in the lead
The bank said that there is a widening spread between the economic performance of certain countries. China has emerged as the first major economy to return to its pre-pandemic growth trajectory, followed by the US.

The euro area and emerging markets, excluding China, are likely to take longer to recover due to slower pace of vaccinations and a revival of infections, it said.

“Central banks are likely to look through a near-term jump in inflation pressures due to base effects from last year’s price drop, given high unemployment rates worldwide,” it added.