Another Monday and another sign that inflation is starting to re-appear in the global economic system (unsurprisingly it must be said given the likely pace of recovery). The latest report comes courtesy of the excellent Variant Perception newsletter HERE and its focus is on food inflation. In the US, food, and beverage directly account for about one-sixth of the CPI basket by weight, but in many EM countries, the weighting is in the range of 30-50%.

Charts Source: Bloomberg, Macrobond and Variant Perception

We’ve already noted in previous blogs that grain prices are rising sharply, but the impact on emerging markets is likely to be much more pronounced, with the potential to produce some EM inflation surprises.

Charts Source: Bloomberg, Macrobond and Variant Perception

According to Variant Perception “Due to the lockdown recession, the underlying resilience of food inflation is being masked, with a notable divergence between EM CPI and food prices at present. The concern is that later in 2021, as global economies recover and re-open, the EM inflation picture could change rapidly as cyclical inflation comes on top of food inflation. We are also tracking Chinese food prices closely in case food inflation there spills over into global food prices. Historically, China’s food CPI and global food CPI have been closely correlated, but the relationship has broken down in recent years due to China’s struggle to contain African Swine Flu, which has caused huge moves in pork and meat prices. The combination of coronavirus disruptions and African Swine Flu drove China’s food CPI to 20% during the depths of their pandemic.”

Back in the markets

SG reports that “Global equity markets ended February with a gain of 2.5% for MSCI Developed and a 0.7% rise in Emerging after a hefty sell-off over the last week, which saw EM give up 6.3% and Developed drop 2.8%. Nasdaq fell 4.9% over the last week but rallied to end the month slightly up 0.9%. Sector-wise the message was as clear as can be, with Industrial Metals & Mining up 12.5% in February, followed by a 7.0% gain in Oil, Gas & Coal stocks. Travel & Leisure also saw strong gains with a 12.7% gain and with bond yields up and the yield curve steepening financial sectors also put in a good showing with global banks up 9.8% and Life Insurance adding 8.3%. The biggest losers included Alternative Energy which fell 9.6%, Pharmaceuticals off 3.7% and Consumer Staples with Personal Care down 4.5% and Beverages off 2.8%. The message then is cyclical risk-on and bond risk off, which is no surprise given the moves in government bond yields so far in 2021.”

According to Tim Edwards, Managing Director, Index Investment Strategy at S&P Dow Jones commodities saw the largest gains, “with the price of oil leading the charge for S&P GSCI Energy (+17%).  Meanwhile, smaller firms continued to outperform in the U.S. as the S&P SmallCap 600® and S&P MidCap 400® gained 8% and 7%, respectively, compared to the S&P 500®’s February rise of 3%.”

In terms of factor styles, SG analysts report that the clear winner was low quality stocks with the greatest returns during February, followed by those companies who had the worst profits growth during 2020.  But “value factors are not necessarily the winners on an absolute basis here. Yes, relatively they will do well as bond-proxies and growth stocks de-rate, but courtesy of the rally seen so far, many recovery names are no longer cheap, or their earnings are still depressed. So, while the low price to book factor is doing well, stocks with high PE s are also doing well, which is why the Value factor is not performing quite as strongly as you might expect.”

Miserable bond investors

Back in the bond markets, the last few weeks have been torrid. Bond prices have fallen sharply and long-term yields have risen markedly, with the UK gilt market, in particular, leading the way.

As Gerry Celaya, chief strategist at investment research firm Tricio reports these sharp moves are putting real pressure on traditional 60/40 portfolios, especially if they are jam-packed full of UK equities and gilts. He observes that the FTSE 100 12 month change is still around -8% (ex-dividends) and “if gilt holdings are taking a knock, the portfolio effect is not clever. Taking the iShares IGLT ETF as a proxy and the 7.1% tumble so far this year is wiping out much of the 2020 8.2% total return. Bond investors need to take stock and consider whether the recent bond market shakeout will consolidate over the rest of H1 2020 and beyond or if this is a trend move that will require moves along the curve (duration management) or reduction of holdings. “