After a very strong recovery, the global economy has shown signs of nervousness.
- Wednesday, November 17, 2021
After a very strong equity recovery in 2020 and early 2021, this summer and autumn has seen the global economy show signs of nervousness. We are suffering what should be short term energy price spikes, supply chain weaknesses and labour shortages that should in time be corrected but there is also a feeling that things are not going as well as we might like. While vaccination rates are globally improving so is Delta variant transmission. Interest rates remain low but inflation is now haunting financial markets and particularly the fixed interest bond markets as central bankers consider the best course to control inflation and maintain growth.
It is quite possible if we can avoid an energy crisis this winter, that the world will transition to a more stable form of growth as markets are progressively weaned off the generous central bank support.
We can expect US interest rates to remain modest while the Feds QE tapering starts. Economists would expect the yield curve to start to rise as tapering continues and the US$ strengthens. As treasury yields rise then expect fixed interest asset prices to fall to compensate.
The opportunity for real estate assets in the right sectors is strong as yields rise from a relatively low base. Property rents do give some protection over inflation. Our alternative assets to equities will in this Edition 36 be focused on property, index linked and short dated credit, target return credit, gold and commodities.
We will retain our equity holdings with some movement to US small cap and mid cap, Chinese and Indian equities and European equities at the expense of US large cap and UK mid cap. Positive returns are expected over the next 12 months from High Yield bonds, equities, real estate and commodities. We are holding some global investment grade bonds and UK gilts as there has been a recent lift in returns and as equity downside protection.
The resurgence of Delta Covid in many parts of the world is seeing high levels of transmission as schools, universities, bars, clubs and as business re-open. However, the vaccine roll out has cut the numbers of people hospitalised and died due to the illness. This resurgence has threatened the economic performance in some parts of the world that had previously managed the initial pandemic well with their stringent lockdown measures such as Japan, Australia and New Zealand.
In both the USA and Europe, the pace of economic growth has slowed as compared to levels of the second half of 2020 and the first half of 2021.This is evidenced by lower retail sales growth from April onwards. This has been interpreted as a pause by analysts as the global economy moves from its early recovery mode to a more normal growth pattern. Early recovery was boosted by government stimulus. The supply chain pressure is a function of this demand. While government and central banks remain supportive the transition to a new normal growth will result in moments of concern and fears of correction, just as we have experienced over the past few months. With the energy problems a very good example. Market volatility is often higher when economic growth slows. For this reason, equity markets can be expected to be choppy. So far markets have taken the Feds decision to start QE tapering very well and emerging markets have not shown nervousness.
As we are in the early to mid-expansion phase of the economic cycle, the cyclical assets that would tend to do well in this phase have again showed that this is the case with property and commodities performing well while the preferred assets for a recession phase such as gilts and gold have generally underperformed but have just recently picked up.
This does not mean we are at all complacent as the world economy is threatened by a number of different challenges from energy supply, labour participation, inflation pressures, central banks tightening and Delta Covid transmissions. Any policy mis-step could result in a correction as we remain in an on-guard state but do expect growth to come through.
We are very aware of the potential impact of inflation and why central banks wish to control it. The rise in the cost of living could continue longer than analysts expect. There is still a majority view that favour a transitory interpretation to the current inflation rate growth. As the global economy returns to a steadier growth pattern, the imbalances that have driven inflation should ease and inflation return to the 2% target range. The labour markets will give the signal for more longer-term inflation expectations.
If we did find ourselves in a longer-term inflationary world of between 3% and 5%, it would be difficult for all asset classes to contend with this well. Our strategy is to invest into index linked bonds, gold, financials and commodities.
Ten-year US Treasury bond yields hit 1.74% in early March and have since declined to 1.3% in August and has since risen to 1.48% in early November. This may suggest that markets are less worried about longer term inflation and that the US has hit peak inflation at 6.2%.
Chris DaviesChartered Financial Adviser
Chris is a Chartered Independent Financial Adviser and leads the investment team.