Source: Bloomberg. Data as of June 21, 2021.
Investing involves risks and you may incur a profit or a loss. Past performance cannot guarantee future results. There is no assurance that any investment strategy will be successful.
The principal Asian semiconductor manufacturers—Taiwan Semiconductor and Samsung Electronics—should be generating sizable profits due to surging global demand and higher semiconductor prices. However, these firms have struggled to produce sufficient chips to alleviate global shortages. Both have had to confront COVID outbreaks and restrictions. Taiwan Semiconductor has faced droughts and fires affecting their water supply (clean water is an essential component in the chip manufacturing process). These constraints on output are temporary, but surging global demand is not. We anticipate that these stocks should recover sharply on the strength of higher semiconductor prices and earnings expectations.
At the other extreme, the Brazilian, Russian, and Canadian currencies, and their local equity markets, have soared on the strength of surging crude oil and metals prices, producing outsized USD returns. For example, in Brazil, higher oil and metals prices have bolstered the local share prices of state energy company Petrobras and certain mining companies, most notably, Vale. Within emerging markets (EM), the positive contributions of Brazil, Russia, and South Africa to EM returns have only partially offset those of China, because those markets, even combined, constitute a much smaller share of the EM index than China. Commodity-linked EM equity markets typically exhibit extreme performance cycles, so one can reasonably anticipate a sharp reversal, especially if/when commodity prices stabilize or slip, or if there is a political-risk event in one of these markets.
Eurozone equities have significantly outperformed U.S. equities, while UK equities have only slightly underperformed. One reason for the higher eurozone returns is a strengthening of the Euro (EUR) against the USD. Investors are anticipating strong European recovery given that the continent is emerging from COVID lockdowns and also given unprecedented actions by the EU and European Central Bank to deliver substantial COVID-related recovery assistance. Eurozone equities are less weighted to growth stocks and are more highly leveraged than U.S. equities to cyclical economic recovery. As for the UK, while some stocks are struggling with the consequences of Brexit, the commodity price rally has bolstered both the Pound (GBP) and the UK-domiciled global energy and metals stocks.
Finally, Japanese equities, in USD terms, have performed relatively poorly against the U.S., the eurozone, and the UK. In part, this is due to the Japanese local public health authorities lagging behind the U.S. and Europe in terms of COVID recovery. It is also due, in part, to Japanese firms’ reliance on the Chinese market, which has slowed somewhat. But perhaps most importantly, it is due to the Japanese Yen (JPY) depreciating against the EUR and GBP. The JPY is a safe-haven currency, so when global equity markets rise, as they have been doing, the currency is relatively weak. If we see increased global equity market volatility, especially a market correction or bear market, the JPY will appreciate strongly against major currencies. So, while Japanese equities have produced relatively disappointing USD returns over the last three months, a significant allocation to the country is important in terms of maintaining a defensive portfolio.
We remain constructive on risk assets, with modest overweight positions in each major equity asset class, as well as high-yield municipal bonds and commodities. Most recently, the Investment Committee added to international developed equities and cash in portfolios, funded from a reduction in investment-grade fixed income. We expect extremely robust U.S. economic growth this year, with the 10-year yield climbing toward 2% and the yield curve steepening, and we have repositioned portfolios with more exposure to value and cyclicals. Short-term risks remain, and volatility is possible, but we expect equities to outperform bonds over a one-year timeframe. We would encourage investors to ride through volatility and use any pullbacks to put excess cash to work.