Global equities put in another solid performance last week, gaining 0.7% in local currency terms. They have now gained 2.4% over the last month and are up as much as 14.6% year-to-date. In sterling terms, equities are up a rather stronger 4.3% over the month but somewhat weaker 12.4% since the start of the year.
This continued strength is a little surprising. We have continued to favour equities in our positioning, so their continued progress is not the surprise here. Earnings and liquidity both remain major supports, as discussed last week. Nor is it that equities have continued to outperform bonds, given the pretty dismal outlook the latter face. Rather, it is the persistence and size of the recent gains, in what after all is typically the weakest time of the year for equities.
Markets are becalmed, with no correction of 5% or more since October, even though the norm is for such a decline every six months. US equities have even posted small gains for seven days running now. This fall in volatility is somewhat at odds with the sizeable uncertainties remaining as the world emerges from its covid-induced coma.
Certainly, a strong global economic recovery is now underway and the risks on this front have diminished. Economies have now largely reopened and, at least in the West, vaccinations are proving effective in limiting the impact of the much more contagious Delta variant. Strong growth looks all but certain to continue over coming months. Furthermore, the fiscal stimulus, along with the spending of savings accumulated during the pandemic, should support growth continuing at a slower but still firm pace into next year.
Beyond that, however, the outlook is much less clear with inflation arguably the biggest cause of uncertainty, even if bond markets seem strangely unconcerned at the moment. 10-year US Treasury yields declined a further 0.1% last week and at 1.43% are now some 0.35% below their high in end-March.
The fact is that inflation has rebounded in the US in the last couple of months much more sharply than expected. The headline rate is now running at 5.0% and the Fed’s preferred core measure at 3.4%. Inflation is also picking up faster than expected in the UK.
The official line of all the major central banks remains that the bulk of the current rise in inflation is only temporary due to a short-term mismatch of supply and demand. But, with bottlenecks now putting upward pressure both on prices and wages, some commentators, far wiser than this one, have pointed out it is simply too early to know how long the upturn will last.
Central banks have also called inflation badly wrong in the past and the central banking consensus is not as uniform as it first looks. In the US, five of the eighteen Fed members are forecasting four or more rate hikes by end-2023 at the same time as five expect none at all. Here in the UK, the just departed Bank of England’s chief economist believes inflation will be up to close to 4% by year-end and that the Bank is underestimating the growing risk of a dangerous rise.
Inflation worries have also started to extend beyond consumer prices. Last week saw news that house price inflation has picked up further in the US and in the UK and is now running at a high 14.6% and 13.5% respectively. This is not a problem yet but if it continues for much longer could become so given the tendency for housing bubbles to end in tears.
Inflation is critical because it will determine how quickly central banks will have to tighten policy. With governments and corporations both now carrying much higher levels of debt, economies will be vulnerable to any remotely rapid rise in rates.
Most likely, it will not be until well into next year that the inflation outlook becomes rather clearer. In the meantime, markets could well continue to believe in goldilocks, namely an economy which is neither too hot nor too cold. We are far from forecasting a return of the three bears any time soon. But we are increasingly aware that markets have now come a long way and even goldilocks is only worth so much.
These commentaries often end with a final word on the UK. But rather than noting that UK equities have suffered over the last month from the rotation away from value back towards growth, we will just note the UK’s triumphs in other areas. Let’s hope next week’s commentary can end in a similar vein.
Chief Investment Officer