Global Markets – 1Q21 Review

International equities maintained their upward momentum into the first quarter of 2021, with the MSCI EAFE Index posting a return of 3.5%.  Below the surface, the rotation from growth to value continued, as the MSCI EAFE Value Index returned 7.4% vs. a loss of -0.6% for the MSCI EAFE Growth Index.  The improved sentiment towards pro-cyclical sectors such as Financials, Energy, and Industrials is largely based on the market’s expectation for a sharp earnings recovery as global economies strengthen in the coming quarters.  And while growth stocks benefited in 2020 from the low rate environment and relative scarcity of technological goods/services, both of these trends have begun to reverse.  Just as an uptick in rates is more damaging to long-duration bonds, rising rates are negative for high growth stocks, as the expected cashflow for these companies is hit harder in a higher discount rate environment.

Inflation and Steepening Yields – False Dawn or Beginning of a Trend?

Market conditions in Europe have taken on a barbell structure in recent years – with investors on one end moving into risk assets in the pursuit of higher returns vs. a crowding into safe haven negative-yielding debt on the other end.

An increasingly relevant question is how will central banks respond to an inflationary bulge resulting from pent-up demand, immense liquidity, supply chain challenges and other fundamental changes in the economy?  Yields are rising all over the world, albeit from different levels.  The European Central Bank (ECB) remains focused on keeping yields low in the sovereign market to ensure the recovery is not hampered.  GDP growth and inflation metrics are also moving higher to varying extents, with expectations rising in the UK/Europe region, although not to the same extent as the U.S.  Central banks are almost certainly going to tolerate temporary overshoots of inflation in pursuit of a sustained real recovery.  The key takeaway is that inflation expectations are rising for the right reasons – growth expectations are improving, and interest rates (the dependent variable) are also rising as conditions improve. 

As opposed to making explicit inflation and interest rate forecasts, the more relevant consideration in Cambiar’s analysis are the potential impacts to our companies’ margin/earnings outlooks should cost pressures arise.  One industry that is currently experiencing raw material shortages is semiconductors.  This is a notable development, as semis have become increasingly ubiquitous in a wide range of end markets.  The current bottleneck is affecting production of PCs, gaming consoles, smartphones and cars – at a time where demand is surging.  The increase in lead times will likely lead to higher prices for consumers, as well as missed revenue opportunities at the corporate level.  Cambiar continues to focus on companies that possess a defensible margin structure (vs. competing on price), and can offset potential increases in materials or labor costs via pricing power and/or continued productivity improvements.