… leave economists and Wall Street baffled
The financial markets appear to have left the pandemic behind them and are now focusing on the short-term effects of rising inflation. At the same time, last week’s April US job creation report has left economists somewhat baffled: fewer Americans appeared to be working last month than in February, and the unemployment rate has edged up to 6.1%.
Needless to say, in light of these figures, this week’s US consumer price index report will be scrutinised by traders, investors and economists. Furthermore, talk of higher inflationary pressures could result in the Federal Reserve Bank tightening its policy sooner than later.
In the Fed’s latest report, Governor Lael Brainard warned of the peril of rising asset prices – they could become vulnerable to significant declines should the risk appetite fall on the back of investors becoming nervous as the economy overheats and inflationary worries take hold.
Federal Reserve Bank Chair Jerome Powell has repeatedly been asked whether or not the central bank is concerned over rising asset prices. He has always said that as long as long-term interest rates stay low, then valuations can be justified. Overall, the Fed appears relaxed regarding the current state of the economy: household balance sheets are in good shape, and corporations are supported by an improving economy and low interest rates… which have allowed default rates to fall.
Nonetheless, even US Treasury Secretary Janet Yellen conceded that interest rates may need to rise to contain the burgeoning economic growth brought on by trillions in stimulus spending. She went on to acknowledge, however, that the economy needs these investments if it is to remain competitive and productive. Both Powell and Yellen have played down fears of inflation, stressing that they have the tools needed to deal with it should it ever become a problem.
… and not just copper and iron ore
As expected, commodity prices are now booming: this is consistent with stronger growth, equity markets outperforming and bond yields rising. As strong export data from China boosts recovery hopes, both copper and iron ore prices have hit record highs.
This growth in mainstream commodity prices has also been accompanied by a surge in demand for other commodities, such as lithium, nickel and cobalt – all metals that are vital for the eventual shift towards a lower-carbon economy. In the world of the future, an abundance of commodities will be required for superior communications, digital infrastructure, transport electrification, renewable energies and smart energy grids. Admittedly, many of the companies that sit within the subsectors of commodities do not always meet increasingly stringent environmental, social and governance criteria. They may be associated with legacy businesses… and of course mining is not without its impacts on the environment. But these new and important commodities are essential if our world is to transition over to a less carbon-intensive model. Suffice it to say, increased demand for these important resources will require higher levels of supply, and producers will need the capital to provide it.
… with an EV promise
In the US, President Biden has already unveiled an ambitious infrastructure spending programme. Part of this will fund the construction of EV charging stations across the country: the aim is to have 500,000 by 2030.
However, more than just government support will be required if EV infrastructure is to be successfully delivered.
Currently, there are not enough electric vehicle drivers on the roads to make this a viable business; and building a network of chargers is both complex and expensive. What’s more, charging times vary from several hours to as little as ten minutes, but the fast chargers being promised by some automakers are currently hugely expensive.
Just as was the case when expensive mobile handsets (with awful battery lives) made their debut nearly three decades ago, it will take some time to create a perfect environment for EV ownership: one that features superfast chargers and is characterised by long-life batteries. Furthermore, higher commodity demand needs to be supported by secure supply – otherwise hyperinflation will occur.
The petrol station forecourt will most likely continue to figure prominently in our lives for some time to come, with petrol and diesel-powered vehicles remaining the most practical choice for long-distance consumer travel. But with legislation now firmly in place to totally eliminate carbon emissions, the race is on to deliver a viable alternative.
… as effective vaccination programmes are rolled out
As far as the pandemic is concerned, global equity markets are now poised to enjoy the fastest global economic recovery in decades, with value and cyclical sectors racing ahead of growth. But investors need to be mindful: many developing countries are still wrestling with the virus, dealing with extremely high case numbers and fatalities.
Effective vaccination programmes are obviously a big part of the solution, and the news that the US has supported a proposal to the World Trade Organisation to temporarily waive patent protection for Covid-19 vaccines means that many developing countries might see an increase in vaccine production.
… while reducing its bond buying programme and keeping interest rates on hold
In the UK, the Bank of England has raised hopes for a stronger economic recovery. This has had a positive effect on both the equity market and sterling. At the same time, recent increases in commodity prices have created a tailwind for the energy and mining sectors.
The Bank of England has also slowed the pace of its bond-buying programme while leaving interest rates unchanged. However, it dismissed all talk of tapering and emphasised that its reduction in bond purchases did not amount to a change in monetary policy.
… as a sector rotation into cyclicals gathers momentum
The Chinese recovery has continued unabated, while Asian exports enjoyed an unexpected surge as the US’s rapid economic recovery catalysed a pick-up in foreign demand for them.
With many factories closed in India due to high levels of Covid, demand for Chinese goods has intensified. The result is that their exports in dollar terms have surged 32% year-on-year, and their imports have grown at their fastest rate for more than a decade.
While the financial markets continue to demonstrate resilience against the threat of any central bank misjudgment (regarding the current inflationary backdrop), investors should bear in mind that any bond tantrum sell-off over the summer months might create a risk-off period for equity markets.
The recent rotation into cyclical value from last year’s growth winners is very much in evidence. There is every likelihood that this will continue over the coming months – particularly as the market widens out to embrace the global economic pick-up.
Therefore, although we remain positive in relation to equities, we are becoming more selective as the global economic recovery gains momentum and moves towards a midcycle period (as evidenced by the improved performance in sectors such as industrials, materials and commodities).