Key points from the month:
- Growing dissonance between rising equity markets and fundamental concerns; will Omicron restore the link?
- Policymakers are changing tack to say controlling inflation lies in controlling pandemic
- Four UK interest rate rises now priced in by the end of 2022, although variant fears may delay this
- Multi-Asset team less positive on convertibles and Japan in Q4 Tactical Asset Allocation review
- Team remains bullish on reflation trade and is positioning for three long-term views: global ex-US equities are more attractive than the expensive US, small caps should outperform large, and value should outstrip growth
Equities largely carried on climbing for most of November, with a growing dissonance between the S&P 500 registering its 66th record high and a lengthening list of fundamental concerns.
News of the potentially vaccine-resistant Omicron Covid variant hit towards the end of the month, with travel companies suffering as governments added various countries, including South Africa, to their red lists. The FTSE 100 was up and down over the last few days of November, serving as a useful case study of the impact of sentiment: the UK’s blue-chip index registered the worst day of the year on Friday 26th only to recover the following Monday and drop again on Tuesday, all with no discernible change in circumstances beyond ebbing and flowing fears around the variant, with the S&P similarly volatile.
In the background, there are also concerns about a broader fourth wave of the pandemic in Europe, higher inflation, changing monetary policy – with comments on faster tapering from Federal Reserve chair Jay Powell sparking a mini tantrum – and a potential plateau in growth. We remain positive on prospects for 2022 overall but again highlight that 2021 has only seen one 5% correction in markets so far, in September. The fact these have historically occurred three times a year on average suggests a pause for breath may soon become inevitable, particularly if worries around B.1.1.529 continue.
As has become the norm, the thick end of market euphoria remains focused around technology stocks, and the behaviour of Tesla head Elon Musk continues to epitomise this. He recently resorted to asking Twitter if he should reduce his personal stake in the business and sold shares worth around $5 billion, which caused the price to fall over 10% in a day. Musk and Tesla advocates will find ways to support this – many of the transactions were pre-arranged and he has millions of options that have to be exercised before next August – but we feel this kind of activity sums up the excesses of the sector, which continues to skew the whole US market.
Elsewhere, Bitcoin remains the poster child for irrational exuberance and last month saw Bank of England (BoE) deputy governor Jon Cunliffe warn these areas are evolving so rapidly that they are becoming a threat to the global financial system. Crypto’s total market capitalisation has swelled from $463.4 billion a year ago to $2.8 trillion today but regulators are yet to impose rules to oversee this space, leading to concerns that continued excessive speculation could spark runs on other seemingly stable assets.
Coming back to policy worries, a 30-year high in US inflation over November dominated headlines, posing more questions over the Fed’s assertions that this rise in the cost of living is temporary. Qualifying some of the statements made over recent months, Treasury Secretary Janet Yellen has said inflation actually depends on the pandemic and controlling Covid will ultimately bring prices back in line – and the latest variant obviously introduces another variable to this situation.
Meanwhile, Powell was re-appointed Fed chair over the month, despite chatter that President Biden might turn to Democrat Lael Brainard to take the reins. Secure for another term, Powell signalled support for faster-than-expected withdrawal of asset purchases and rate rises, citing a very strong economy and inflationary pressures. With US core inflation climbing 0.6% in October, even with volatile energy and food prices stripped out, there is obvious context for his comments.
In the UK, markets were wrong-footed by mixed messages from the BoE, which decided to keep rates on hold despite signals a hike was imminent and predicted inflation of 5% by spring. While only two of nine Monetary Policy Committee (MPC) members voted for a rise, Governor Andrew Bailey said the decision was close and a first hike since 2018 is now expected in December or February, although Omicron may well delay this. In the current environment, characterised by surges in electricity, gas and fuel prices, it is also unclear what impact a modest rate rise would have, especially as markets have already priced in four by the end of 2022.
On inflation, the MPC said it expects headline Consumer Price Index (CPI) to peak in April then fall back materially in the second half of 2022 as energy prices come down, and October’s 4.2% print – higher than the predicted 3.9% – suggests we are well on the way towards that. Supply chain bottlenecks and weaker consumer spending have resulted in the Bank halving growth forecasts for the third and fourth quarters and it now believes it will take until Q1 2022 for the economy to regain ground lost during the pandemic.
Views on the cost of living situation appear to be coalescing into two camps: those who accept central bank rhetoric that the rise in prices will prove temporary – where we continue to sit, at least looking to the medium term – and others who fear we are entering a 1970s-style period of high inflation, deflation or even stagflation. What we actually get may ultimately fall somewhere in the middle, with greater inflation volatility and a growing gap between interest rates and headline inflation. Michael Saunders, one of those two MPC members calling for an immediate rate hike, cites a tight labour market and signs of a pick-up in wage growth as reasons for his stance but even he dismisses comparisons to the 1970s, and the energy crisis that sparked most of the inflation issues then look unlikely to reoccur. What we do have is a world with huge debt-to-GDP ratios and many countries where low interest rates have become requisite fuel for economic growth, and so anything to change that will create volatility.
As the year nears its end then, what can we say about prospects for 2022 and beyond? We outline our outlook in more detail in the accompanying article but to summarise, we remain positive on risk assets, seeing interest rate hikes and tapering of asset purchases as positive signals that the global economy is starting to reach escape velocity from the pandemic.
BofA Global Research is among the more bearish commentators out there, claiming there are too many similarities between this year’s retail stock trading mania and hectic flotations and 2000’s dot.com bubble to ignore. To play devil’s advocate, however, the group also suggested several reasons to be positive on US equities – and we would extrapolate a couple of these into a more optimistic view on markets in general. Point one is the fact it is often dangerous to underestimate corporate America and we feel there should be plenty of market-driving innovation to come globally as the world moves past the pandemic (for more on comparisons to the Roaring 20s, see our 2022 outlook).
A couple more ticks in the equity column are its yield and inflation-protection characteristics in a period of higher inflation (commodities offer inflation proofing and bonds provide yield but neither gives both) plus potential for ongoing small-cap leadership. We would add high corporate profit margins and earnings, long-term interest rates remaining below growth rates – even after any hikes – and huge amounts of liquidity still on the sidelines.
Across our funds and portfolios, we continue to be bullish on the reflation trade and are positioning for three long-term views: global ex-US equities are more attractive than the expensive US, small caps should outperform large, and value should outstrip growth, all of which run contrary to what happened for most of the 2010s. As part of our latest tactical asset allocation review, we reduced two asset classes on our one to five scale (with one most bearish and five most bullish), with convertibles and Japanese equities both coming down from four to three. On the former, we are taking profits after a strong spell of performance for the asset class, while our view on Japan has come off slightly as we prefer to spend our equity risk in areas such as Europe and the UK.
Key Risks
