What to look out for in the week ahead

A muted start, but there could be more gains to come

It’s been a fairly dull start for financial markets this morning, with European indices giving up some ground, while the UK’s FTSE 100 is up a touch at 0.1%, although it has, for now, given up the 7,000 level. Investors are weighing up two opposing drivers: rising energy prices and a strong inflationary impulse versus exceptional earnings results. These are big themes that will need to fight it out over the coming months to see who wins and that will ultimately drive markets in the medium to long term, however, in the short term, economic data and the bond market will both be strong drivers of stocks and other risky assets.

Treasury yields remain supportive for risk

As we start a new week, the 10-year Treasury yield has fallen sharply, it is currently trading below 1.6%. The driver of lower Treasury yields (higher prices) may be the $40bn sale of 42-day bills later on Tuesday, which could focus minds on the demand out there for US government debt. However, it still seems odd that Treasury yields do not appear to be able to hold onto gains for long at the same time as economic data is picking up, US states and parts of Europe are preparing to exit coronavirus restrictions and inflation data is threatening to run hot. Is the market finally starting to believe the Fed when it says that inflationary threats will be temporary only?

Investors turn testy on new tech

Let’s face it, at the moment, low or muted interest rates are supportive of many big players in the market including the tech sector and overall market bulls. Tech stocks love low interest rates as it flatters future projected profits, and bulls love low interest rates since they can borrow cheaply to buy more stocks. At this late stage of the market rally, we could carve the market into a few different sections. Firstly, old tech – this is Microsoft, Amazon, Apple etc. They continue to trade well and are close to multi month highs after a stellar first quarter of earnings that were reported last week. However, the performance of new tech, especially tech that has been linked to coronavirus, has been extremely weak. Zoom, last year’s tech darling, remains in the doldrums as economies open up and office workers return to their workplaces and leave their homes. Likewise, food delivery firms Door Dash in the US and Deliveroo in the UK are failing to gain traction. Although stock indices are still at high levels, some of the tech darlings from last year are suffering. Along with Zoom, Snowflake, the data cloud service that listed to much fanfare last year, has seen its shares plunge as the market is starting to punish those stocks that launched with massive valuations in 2020. Right now, the market is looking at stocks that have a good macro story, largely those that will benefit from the opening up of economies; the market is also rewarding strong corporate results. Tesla is a company that straddles both of these criteria – it’s product – electric vehicles – will likely continue to grow in popularity, but even though it reported record-breaking profits in Q1, the market remains concerned about profitability in the future. Tesla’s share prices fell 3% on Monday and are expected to fall another 1.5% on Tuesday. These declines come on the back of news that Tesla’s European factory near Berlin has delayed its opening and will not start production until January 2022. This has stoked fears about a delay in Tesla’s ability to grow profits, which is weighing on the share price.

Corporate fundamentals in the driving seat

Overall, the market is too hot for some investors, but we remain optimistic that the rally has further to go. Firstly, because Treasury yields have not been able to sustain elevated levels as the market comes round to the Fed’s way of thinking that further support is necessary to see the US (and global economy) out of this pandemic. Secondly, corporate earnings remain strong on both sides of the Atlantic. 60% of the S&P 500 have reported Q1 2021 earnings, of those that have reported earnings 86% have reported a positive EPS surprise and 78% have reported a positive revenue surprise. Of those that have reported, only 18 companies have reported negative future economic guidance, while 30 have upgraded their future economic outlooks.

Analysts are also upgrading their estimates for Q2 earnings in the US. Usually, analysts tend to revise down Q2 earnings expectations, however, this year, according to FactSet, bottoms-up EPS estimates (which is an average of EPS estimates for Q2 for all companies on the index) is a whopping 4.2%, led by energy, financials, materials and communications. Interestingly, consumer staples and consumer discretionary sectors have seen their EPS estimates revised lower for Q2. Even with the consumer sector getting a downward revision, the market is still excited about earnings estimates. Thus, another quarter of strong earnings growth, combined with low interest rates and falling Treasury yields could see further gains for stocks once the market settles into May’s trading groove.

GBP could benefit from strong UK data

This is a busy week for economic data, with PMI data for April, European retail sales and German factory orders some of the highlights. Watch out for two things that could impact markets in the UK this week. Firstly, the market is looking for confirmation of a strong service sector PMI for last month, when the UK’s service sector partially reopened; this could help GBP to take back the $1.40 handle versus the dollar, especially since Treasury yields have been falling. Secondly, we remain optimistic on equities and think that IAG – the parent of BA – could have further to go as the British government confirms the opening up of non-essential travel for British tourists later this month. We believe that the sheer scale of bookings could see further upside for IAG.