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10th September 2021
InsightsMarket CommentaryStayInTouch

Graham BentleyGraham Bentley

August has not been short on incident.

On the political front, the collapse of the Afghan government's defences against the Taliban was the catalyst for a somewhat chaotic withdrawal of US and NATO forces. China continues to exercise party control over its technology companies, while its military has expanded its activities around Taiwan, increasing speculation that a move to retake that island is on the cards. President Biden’s foreign policy centred on rejection of “Forever Wars” is being tested. 

Reopening of major economies releases pent-up wave of consumer demand

Meanwhile COVID continues to weigh on global economic performance, as the delta variant dominates virus transmission particularly in the UK and US. However, while a third wave of infection rolls around the globe, vaccination programmes have mercifully slashed the number of hospitalisations and deaths; this encouraging development has hastened the reopening of major economies (e.g. the UK largely came out of lockdown on 16th August) with an associated pent-up wave of consumer demand – both spending and borrowing -being released.

Companies’ half year profits generally much higher than expected in western economies

Western economies' companies have posted half-year earnings and profits generally much higher than analysts had expected. As a result, investors in equity-biased portfolios should have seen satisfactory gains over the year to 31st August. The S&P index of the largest 500 companies in the US achieved its 54th all-time of 2021, and seven straight months of gains; that benchmark is now up over 20% year-to-date. Smaller companies in the UK and Europe continued to excel as their home markets are revitalised, up over 27% and 20% respectively this year; indeed over the first half of 2021 the rebound in dividend payments of companies listed on the AIM market was more than twice as strong as their larger peers on the main market.

Some after-effects of 2020's COVID-shock remain

While respective global economies are in various stages of emergence from lockdown, the after-effects of 2020's COVID-shock remain. Supply bottlenecks and delayed port infrastructure development mean that over 350 container ships are anchored outside ports around the world, many of which have little prospect of imminent unloading. The largest of these ships can carry 20,000 6-metre containers, requiring thousands of lorries and freight trains to distribute their contents to factories, warehouses, shops and homes. Lorry drivers are in short supply; EU-based drivers have returned home post-Brexit, while last year over 30,000 Heavy Goods Vehicle (HGV) driving tests were cancelled in the UK due to COVID. Qualified drivers are being offered bonuses and up to 40% wage increases to switch jobs to supermarket deliveries, to restock increasing shelf space. The cost of hiring shipping containers has quadrupled this year, while the prices of many basic building materials such as cement and plywood have more than doubled in less than a month. In the US, the rate at which people are quitting their jobs, and the number of job vacancies are both at historic highs. This suggests that job seekers are in a strong bargaining position despite elevated unemployment.

Post-COVID spike in western economies' inflation rates may be more long-lasting than assumed

This is increasing evidence that the current post-COVID spike in western economies' inflation rates, while temporary, may be rather more long-lasting than was assumed. Any prospect of sustained price and wage inflation would normally put significant upward pressure on interest rates. Bonds with resulting inferior interest payments would see their yields rise to compete, engineered by a fall in their prices. Indeed, the extent to which global investment portfolios hold bonds has been falling for two years; the Bank of America Global Fund Manager Survey indicates that managers' portfolios have their lowest weighting in bonds this century. Despite this apparent lack of demand, the yields on Bonds remain historically very low. This is because US, UK and European central banks continue to pump money into their respective economies by buying back bonds at an unprecedented scale. U.S. retail banks bought a record $150 billion in US Treasury bonds last quarter, hugely expanding their holdings relative to the new loans they have written. When an economy is growing, banks usually have no problem finding borrowers; loans provide banks with higher returns than parking their money in low-yielding government bonds. However, during the pandemic, the US government gave $830 billion in stimulus cheques to individuals, as well as $570 billion in enhanced unemployment benefits. That allowed many people to pay down debt and avoid new borrowing. The Paycheque Protection Programme also artificially propped up small-business lending during the worst of the pandemic. With loan demand remaining slow, lenders are having to buy bonds that generate negligible returns.

Fed to err on the side of caution where inflation is concerned

Finally, the annual meeting of the US Federal Reserve took place at the end of August. Despite signalling the start of a slowdown in the Fed's $120 billion a month bond purchasing programme, Chair Jerome Powell gave markets a boost by definitively separating interest rate policy from any strategy to taper bond purchases. He indicated the Fed would err on the side of caution where inflation was concerned, avoiding precipitous action to offset what may prove to be a temporary inflation problem; if it isn't broken, don't fix it. This is a real positive for both bonds and equities as that element of uncertainty is removed.

Governments seek other means of recovering COVID expense; tax rises are almost certain

In summary, the continued rise in western stock markets, despite what appear to be severe headwinds obstacles to their growth, can be explained by TINA, or "There Is No Alternative". Bond yields remain at historic lows, with even low quality "junk" corporate bonds being expensively priced. After years of market support post 2008, and $14 trillion of support for their economies during 2020 alone, central banks (and the US Federal Reserve in particular) are now signalling their readiness to turn off the tap before too long, but not necessarily with an associated rise in interest rates. Governments meanwhile have to seek other means of recovering COVID expense; tax rises are almost certain to feature in that strategy, irrespective of party policy. 

Diversification - the sensible investment strategy for the longer term

While we may be looking at a political and economic “new normal”, diversification within multi-asset portfolios should prevail as the sensible investment strategy for the longer term.

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