Vaccinating against Bubbles

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Global equities posted further gains last week and are now comfortably above their highs prior to the mini-correction seen a couple of weeks ago. In local currency terms, equity markets ended the week 1.5% higher and are now up 5.9% year-to-date.

There was no specific news to drive markets higher last week. Rather, they continued to benefit from the very supportive monetary and fiscal policy backdrop, the encouraging picture on vaccines and the positive earnings surprises in the current reporting season in the US and Europe.

Last week’s UK GDP numbers came in higher than expected, with activity rising 1.2% in December and gaining 1.0% over the fourth quarter. But they were no cause for celebration. GDP was still down 7.8% in the fourth quarter compared with a year earlier, a rather larger decline than seen in most other economies. Moreover, the economy shrank 9.9% in 2020, the largest contraction since the Great Frost of 1709.

The recent bounce in UK activity looks certain to be reversed and more in the current quarter. However, markets have their eyes firmly focused on the prospect of a strong rebound in the UK and elsewhere from the second quarter onwards. This is based on a rapid vaccine roll-out and, despite the slow start in the EU, the bigger picture is encouraging.

The UK has met its target of vaccinating 15mn people by mid-February and the roll-out in the US is also picking up speed. There is now talk of 50% of the population being vaccinated in the UK by April, in the US by May and in the EU by June. Even if this proves a tad optimistic, the roll-out should be sufficient to allow a major relaxation of social distancing measures in the second quarter.

The vaccine roll-out will be the major force driving the rebound in growth in the UK and the EU. But in the US, it will also be down to a large fiscal stimulus. With the distraction of Trump’s impeachment trial now behind us – he was acquitted as expected with only seven of the fifty Republican senators voting for his conviction – Congress can now focus on the forthcoming fiscal package. This looks likely to total some $1.5trn (or 7% of GDP) and follows hard on the heels of a $900bn package at the start of the year.

So, we are talking big numbers which are already prompting fears in some quarters that such a large stimulus will end up causing the economy to overheat and a surge in inflation. We certainly believe underlying inflation will pick up over the next year or two but to no more than 2-2.5%, which would be a welcome rather than unwelcome development.

All the same, inflation worries look set to continue, not least because of the rebound in oil prices to above $60pb from their lows last April of below $20pb. This will lead to a temporary spike in headline US inflation above 3% over coming months.

Inflation is not the only source of worry for some with talk of bubbles bubbling along. The surge in GameStock may have ended up being a one-week wonder but that in bitcoin is proving more enduring. On the back of last week’s news that Tesla has invested $1.5bn in the cryptocurrency, its price has hit $49,000, up from levels of around $10,000 seen for much of last year.

While we are in the bubble camp as far as Bitcoin is concerned, we don’t believe the same is true for equity markets more generally. Equity valuations still look reasonable, relative to bonds at least, and the sharp gains in price are justified by the very supportive economic backdrop. While inflows into equities have picked up sharply recently, there is still considerable money on the side-lines looking for a home. Even if this is a bubble – which we don’t believe it is – this suggests it has room to inflate significantly further.

Rupert Thompson

Chief Investment Officer