Equities continued their upward trend in July, the ASX 200 Accumulation Index finished the month 1.1% higher and the MSCI World index in $Au was 2.8% higher.

Concerns over the Delta variant’s potential to derail economic recovery, both domestically and overseas have dominated headlines. Nevertheless, equity markets remain resilient.

US employment data at the end of the week was a reminder that economic growth may prove more resilient than the market thinks. There are some indications that the supply bottlenecks which caused the spike in short-term inflation may prove more persistent than first thought. For example, the number of ports seeing capacity issues has increased. In addition, Delta’s rise in Asia is also raising concerns for global supply chains if lockdowns remain in place. Anecdotally, US auto dealers are sitting on several million fewer cars in inventory than would normally be the case at this time of year. The upshot is that inflation concerns are still real, despite what the decrease in bond yields in recent months might suggest.

On the face of it shares and bonds seem to be telling us a contradictory story, with bond markets seemingly more worried about the threat to growth from Delta but shares just powering on. There are however a bunch of factors driving the divergence. Bond markets are focussing more on the risks to short term growth, ongoing quantitative easing (QE) keeping bond yields down and confidence that the inflation spike will be transitory, whereas shares are being boosted by strong earnings, easy monetary policy, the valuation boost from lower bond yields and optimism that vaccines will ultimately allow global recovery to continue. While shares are at risk of a short-term correction, we ultimately see the rising trend continuing and bond yields likely trending up again once it’s clear that economic recovery will continue despite the short-term disruption from Delta.

The latest wave of new coronavirus cases is continuing to build. New cases are continuing to rise in Asia – including in Japan and China, Africa and the US.

While new deaths are rising globally this is mainly in less developed countries with vaccines providing protection against serious illness & death in developed countries.

Australia’s vaccination rate is continuing to rapidly accelerate, reaching 1.28 million doses over the last week, reflecting increased vaccine availability and a sharp fall in vaccine hesitancy. Australian governments have agreed on a national plan that would see a move from the current “suppression” of the virus phase to a “transition” phase with less restrictions and less city and state lockdowns once 70% of the adult population is vaccinated. It would then move to a “consolidation” phase, with only targeted lockdowns and greater international travel once 80% of the eligible adult population is vaccinated. At the rate of 1.26 million doses a week, Australia should reach 70% of the adult population (55% of the total population) fully vaccinated in November and 80% of adults (63% of the whole population) in December, from 17% now.

US earnings season continues to be very strong. The S&P 500 is beating quarterly earnings forecasts by 25%. Re-opening stocks have fared best, beating expectations by 45% on average. However, the stocks have not reacted given concerns over Delta.

Upgraded CY21 earnings expectations means the S&P 500 is now on 21x earnings. This isn’t cheap, but is reasonable given rates. At this point the consensus is only for 5% earnings growth in CY22.

Australian data was on the soft side, with further evidence of the impact of lockdowns becoming evident. Real retail sales rose strongly in the June quarter but fell sharply in June and are set to see further declines as lockdowns bite. Job ads fell in July for the first time in 14 months and payroll jobs are also down, led by NSW. The trade surplus rose to a new record high, which is great, but this is due to high prices (particularly for iron ore) so net exports are likely to detract from June quarter GDP.

The Australian June half profit reporting season will start to ramp up in the week ahead, Consensus earnings growth expectations are for a 50% rise in earnings for 2020-21 and a 56% rise in dividends. The resources sector is expected to see a doubling in profits, followed by 58% growth in bank earnings. Outlook statements are likely to be cautious given the uncertainty posed by recent coronavirus outbreaks and lockdowns.

Shares remain vulnerable to a short-term correction, with possible triggers being the upswing in global coronavirus cases, the inflation scare and US taper talk and geopolitical risks. Looking through the inevitable short-term noise however, the combination of improving global growth and earnings helped by more fiscal stimulus, vaccines allowing reopening once herd immunity is reached, and still-low interest rates augurs well for shares over the next 12 months.

Expect the rising trend in bond yields to resume as it becomes clear the global recovery is continuing.

Cash and bank deposits are likely to provide very poor returns, given the ultra-low cash rate of just 0.1%. We remain of the view that the RBA won’t start raising rates until 2023.

Important note: While every care has been taken in the preparation of this document, Farrow Hughes Mulcahy make no representations or warranties as to the accuracy or completeness of any statement in it including, without limitation, any forecasts. Past performance is not a reliable indicator of future performance. This document has been prepared for the purpose of providing general information, without taking account of any particular investor’s objectives, financial situation or needs. An investor should, before making any investment decisions, consider the appropriateness of the information in this document, and seek professional advice, having regard to the investor’s objectives, financial situation and needs. This document is solely for the use of the party to whom it is provided.