Three themes for April

As Europe emerges from a chocolate-egg filled weekend, three themes are starting to emerge as we enter Q2. Stock markets are making fresh highs and European indices are starting to return to their pre-pandemic levels. As we move through the year and as vaccination rates across the world start to pick up, there is a levelling up in global stock markets, with previously unloved sectors and regions starting to play serious catch up with the US and tech stocks in particular. 

1, The global corporate tax rate and implications for markets 

This initiative has come fairly early on in the Biden administration, and along with record-breaking levels of stimulus and infrastructure spending, President Biden is making his mark on the US economy in a progressive and bold fashion. Biden’s proposal is for the world’s biggest multinationals to pay corporate taxes based on their sales in each country. The plan would see the world’s largest companies paying taxes on their global profits even if they do not have a physical presence in those countries. Hence the US tech giants would have less scope to avoid paying corporate tax rates that reflect their true size and profits as they have been accused of doing in the UK and in Europe in recent years. The plan has been sent to 135 countries who are negotiating international taxation at the OECD. While it is easy to see that there could be a backlash against these plans, especially in countries with powerful fiscal conservative parties, i.e., the USA, even if such a plan did not get through the US Congress, if the majority of countries at the OECD did agree to international corporate tax rates, then it would allow President Biden’s administration to implement higher corporate tax rates at home without the threat of being undercut by other countries. On the face of it, these plans look sensible and fair. Some of the world’s biggest companies, such as tech giants like Amazon, have earnt record breaking profits at the same time as governments around the world have had to spend record-breaking amounts on fighting coronavirus. In a pre-covid world the talk of international corporate tax rates could have caused panic in financial markets. However, these days such a global tax plan makes sense to society and investors. The debts accumulated to fight this crisis need to be paid off otherwise they could destabilise financial markets, thus a global plan to raise tax rates will help to do this without penalising any one country. Interestingly, stock markets continued to rise on Thursday and even smaller countries that have lower tax rates, for example Ireland, only saw small selloffs. The Irish stock market, the ISEQ remains close to record highs, and Singapore’s stock index closed higher on Thursday. Thus, in the current environment, a higher rate of global corporation tax may be a good thing for markets, as it makes individual country’s debt levels look manageable as the global economy recovers from the impact of coronavirus and multiple economic lockdowns. 

2, Treasury yields stabilise 

This week we have seen US Treasury prices rise (yields fall) as the market digests the prospect of higher corporate tax rates and the persistently dovish tone from the Fed. Minutes released from last month’s Fed meeting were dovish in tone, suggesting that the majority of Fed members do not see a sustained rise in inflation any time soon and the minutes also reiterated the Fed’s commitment to keeping interest rates low for as long as the employment rate takes to recover from the pandemic. This has helped to ease the upward pressure on Treasury yields, the 10-year yield is now 1.62%, while the 2-year rate is 0.15%. Lower interest rate expectations and lower Treasury yields are good news for the tech sector, as lower interest rates make predicted future cash flows look higher compared with rising interest rates. The recent move in Treasury yields suggest to us that financial markets are starting to reassess how quickly they expect interest rates to rise. While last quarter was all about sovereign bond market volatility, especially in the US and the UK, we think that Q2 will see bond markets stabilise and the 10-year Treasury yield could settle between 1.6-1.65% in the coming weeks. A stabilisation in Treasury yields, and the prospect of a slower pace of Treasury yield upside, has an impact on financial markets. Firstly, it is good news for stocks, and has taken the edge off the global corporate tax news, even Apple and Amazon were up 1.9% and 0.7% today. Secondly, it is good news for gold, since the yellow metal tends to rise when Treasury yields fall. It may also slow down the speed of dollar appreciation, although we are still looking for the dollar to make decent gains this quarter on a broad basis. 

3, what next for the pharma sector 

During the past 12 months the world has relied on the pharma sector and research scientists like never before. The rush to find a Covid vaccine has sent a shockwave through the pharma sector, with some notable winners and losers. For example, Astra Zeneca is down more than a fifth in the past year, as investors worried about the impact of producing a Covid vaccine at cost. Moderna and Pfizer, other big Covid vaccine producers, have fared better, but they have seen their share prices fall since late November/ December when the announcement that the first vaccines had been found first went public. Johnson and Johnson’s share price has fared better, possibly because its one-dose vaccine could prove a hit in the coming years. The reason why pharma stock prices have not consistently reaped the benefit from producing the vaccines that will unlock the global economy from its covid paralysis is due to a couple of factors. Firstly, R&D spending has been huge. This has eroded profits at Moderna, for example. While R&D spending should fall this year, investors are worried that new, vaccine-resistant strains of coronavirus will mean that pharma companies will see elevated R&D costs for some time. Added to this, the focus on covid, especially for AZ, Pfizer and Moderna could lead some investors to worry that they have taken their eye off the ball on other lucrative drugs. The stock with the most potential this quarter, in our view, is Astra Zeneca. It is producing its vaccine at cost, which is something that investors did not like, added to that the vaccine has proven controversial and even the UK has now stopped administering it to the under 30’s. However, in the coming months we think that concerns about the vaccine will die down, once enough people are vaccinated and, hopefully, covid is in the past. At this point, the market will focus on what the future holds for the pharma sector. The UK’s larger vaccine production capacity post covid and the fact that UK based scientists have proven to be world class yet again, leaves Astra Zeneca in a good position for the future. It is for these macro reasons that we see AZ’s share price rising during the coming months.