Q2 Equity Strategy: Focus on Inflation

The shift to a new policy regime, along with Covid vaccine roll-out, has been positive for Equities which have outperformed Bonds by almost 9% over the last 3 months.

The key risk for markets is the degree that inflation will rise in coming months: the current consensus is that core inflation will remain muted even if headline inflation rises c/o base effects from Oil prices, but our indicators suggest that the risk (even to core CPI) is on the upside, not the downside. Such a move would favour Cyclicals and Value relative to Defensives and Growth.

With Covid cases rising, it may be tempting to rotate back to Defensives, with the likes of Healthcare looking oversold and cheap vs. the market. But, if inflation breaks higher, Cyclical sectors and markets with high Cyclical exposure will be the winners.