Delta variant fears swirled around markets over a partially sweltering July, with the majority of restrictions in England lifted – at least for now.
Of course, this was surrounded with the usual series of gaffes and U-turns, with nightclubs declared superspreader hotspots hours after opening, masks on, off and on again, and, amid hundreds of thousands hit by the so-called pingdemic as the track and trace app ran wild, we had the prime minister and chancellor initially refusing to isolate before bowing to pressure. Even the weather joined in, with high temperatures giving way to torrential rain and flooding – and we will be returning to that theme later.
For anyone hoping the UK’s so-called Freedom Day on 19 July might see Covid’s role as the main driver of sentiment start to diminish, the month was a stark reminder that the virus remains central, even as politicians attempt to start moving the narrative from pandemic to endemic.
We have been saying for some time that a fall in markets is overdue and while still yet to see an overall decline of 5% in the S&P 500 in 2021 – as a reference, such falls tend to happen at least three times a year – certain sectors were down considerably more mid-month amid those variant concerns. Many of the more cyclical areas that have propelled markets this year fell over 10% from peaks, with some airlines dipping into bear territory (down 20%) as confusion continues over travel restrictions. Showing its elasticity, however, the index had rallied back to highs by month end, potentially on the back of dip buying.
Looking around the world, Asian markets in general had a tougher July, weighed down by gradual tightening in monetary policy and a sweeping regulatory overhaul in China, which has seen the government clamp down on lending practices of several big tech companies, including Alibaba, Tencent and Meituan.
While remaining positive on risk assets, we feel relentless moves upwards over recent months have left some markets exhausted and obscured growing turbulence beneath the surface, not just from inflation fears picking up but also from vaccine euphoria giving way to concerns about the durability of recovery. This has led to economists warning the speed of economic recovery may be unsustainable, with the UK predicted to grow 6.8% this year and the US by 7%.
While the pent-up demand used to justify such predictions is clearly there for things denied to people during lockdown, such as eating out, live entertainment and travel, there is far less appetite to repeat spending sprees on cars and home furnishings. We have therefore seen a huge pull forward in demand and while this supports the transitory inflation argument, it may also pave the way to cooling economies that miss aggressive growth predictions, and we have seen early signs of this in the US.
The rate of inflation in the UK edged up in June, reaching a three-year high of 2.5%, while the US Federal Reserve met again in July in the wake of prices hitting a 13-year high, driven by a rise in the cost of used cars. While the Federal Open Market Committee is increasingly divided between hawks, doves and centrists on how – and, more importantly, when – to tighten policy, anyone expecting definitive statements on tapering or rate rises was left waiting once again. The Fed held its benchmark interest rate near zero and said the substantial further progress on employment and inflation that would spark rate hikes or slowing, and ultimately stopping, bond purchases still has ‘some ground to cover’.
That said, the Bank acknowledged progress on these measures and remains positive on the economy overall, despite the threat of the Delta variant, with Q2 GDP growth coming in at an annualised rate of 6.5%. While well below the projected 8.5%, this latest surge puts GDP above its pre-crisis peak for the first time and, reinforcing FOMC comments, showed that while the labour market remains far from fully healed, output has now fully retraced its virus-fuelled decline.
Meanwhile, Fed chair Jay Powell has also attempted to calm inflation fears yet again: at a recent congressional meeting, he said the US is not going into a period of high inflation for a long period of time because it has the tools to address this, but is keen not to use them ‘in a way that is unnecessary or interrupts the rebound of the economy’. Given this underlying prudence, all eyes now turn to the annual Jackson Hole conference of central bankers in August for potential updates on hikes or tapering. The likelihood of a rate rise in 2022 increased to 62% after the Fed meeting, with futures now fully pricing in the first hike by March 2023.
While aggressive tightening is clearly not on the agenda, the world needs to get comfortable with a new status quo where crisis-level monetary policy is no longer essential. Assuming vaccination efforts continue and the pandemic recedes, we see the global economy moving into a mid-cycle expansion, with the focus shifting from recovery to more sustained growth. Following recent peaks in policy support, growth and markets, we would expect to see global GDP moderate to above-trend levels next year and more active stock selection will be required in such an environment, with the broad rally since last year’s vaccine announcements thinning out.
Risk assets such as equities and credit tend to perform well in a mid-cycle phase but with significant differentiation, and it will be interesting to see how more value-orientated sectors like financials and industrials fare as we move beyond the recovery stage. As always, while we have had a slight bias to value since last year, we continue to believe portfolios able to tilt between styles while keeping a foot in several camps offer a compelling and diversified risk/reward balance.
To finish, as this is a summer commentary, I have a couple of anecdotes from my recent holiday. I was lucky enough to spend two weeks in Barbados for my thirtieth wedding anniversary and, as always, was unable to switch off from markets entirely. My first thought was around the importance of avoiding insular thinking when it comes to investment, particularly in the context of recent commentary about recovery from the pandemic. Areas such as the US, UK and, increasingly, Europe continue to enjoy successful vaccine rollouts and these economies clearly have an outsized impact on overall rebounding growth; but deserted beaches and hotels in one of the world’s premier tourist hotspots, and a tiny number of Barbadians having had vaccinations so far, shows how far huge swathes of the world are from normality.
Many countries are struggling and likely to do so for years to come, which is important to remember when considering the ‘global’ recovery. Over recent months, terrible scenes from India provided a sharp reminder of the risks in less-vaccinated economies, and even Japan, which is among our favoured equity markets, has suffered a market backlash over the second quarter on the back of rising Covid cases and slow vaccine progress as the country grapples with hosting the delayed Tokyo Olympics.
A second – weather-related – point was around Hurricane Elsa hitting the island when we were there and hotel staff showing the benefits of preparing for circumstances rather than reacting to them when they occur, a key part of our investment philosophy. June and July are the peak rainy season in the region and as soon as the warning came in about a possible storm, the hotel moved into action, clearing away anything that could cause damage and, with an island-wide lockdown in place, ensuring people were safe and looked after in their rooms.
Whatever service people buy, whether a holiday or investing in multi-asset portfolios, they want to feel looked after. This focus on potential downside is exactly what we do, making sure we have a plan in place to achieve ultimate client outcomes whatever market storms we may have to face along the way.
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