Global equity markets seem to be looking for directional guidance from central banks and the third-quarter corporate earnings season – whatever the outcome may be. They also appear highly sensitive to developments in China.
Perhaps the immediate challenge facing us, however, is the growth-inflation mix: growth is receding and inflation is very much on the rise. The result is nervousness and uncertainty. Is current monetary policy the right one? And are we heading for a period of stagflation?
Many commentators still subscribe to the view that inflation will fall back next year. But the current upward pressure on prices has already lasted longer than was expected, giving rise to concerns that a more fundamental shift in inflation dynamics might be at play.
The other major unknown – about which the markets need clarification – is the timeframe for the US central bank reducing the pace of its monthly bond-buying programme. Recently-released minutes of the Fed’s meeting suggest that the tapering process could begin as early as November.
Further short-term challenges are being created by supply chain issues, labour shortages and higher energy prices. All of this is making the third-quarter US earnings season even more interesting than it usually is: analysts will be scrutinising the forward guidance statements issued by senior management officials, together with any commentaries about inflation and supply chain disruption.
In China, the recent regulatory clampdowns and property upheaval have been somewhat eclipsed by surging coal and other commodity prices, pushing inflation up to its highest level since 1996. This has ramifications for the world economy. Indeed, only last month the Organisation for Economic Cooperation and Development forecast that prices in the G20 group of major economies would grow faster than they did before the pandemic for at least another couple of years.
On the currency markets, the US dollar remains sensitive to monetary policy as the Federal Reserve Bank moves closer to tapering its bond-buying programme. Similarly, government bond markets appear to have priced in the possibility of an earlier interest rate hike, and this is being reflected in the behaviour of both the equity markets and its investors.
But much could depend on how the central banks respond to the build-up of higher inflationary pressures and whether they continue to believe that they will be short-lived. The International Monetary Fund recently indicated that it was in agreement with the Central Bank regarding inflation, and that it would eventually drop back. But it admitted that there was “high uncertainty” over the issue and advocated vigilance.
While we do not expect the Fed to raise interest rates any time before 2023, any rapid tapering of its monthly bond buying might increase the possibility of that happening earlier.
Whether this current period of inflation is indeed transitory or more deeply embedded in our global economy, successful compounding and returns remain contingent on owning quality companies with strong balance sheets and pricing power. Inflation is the silent thief that robs us blind: quality and pricing power protection are crucial in our portfolios.
These compounders are important: they have the ability to sustain revenues – even when demands on the global economy are more stressful or – worse – when it starts to contract. It is becoming evident that we will soon experience a shift and will start moving into a new phase of monetary and fiscal policy. This will require some slight alterations to global asset allocations, but our view remains that the robustness of our strategies will continue to deliver sensible risk-adjusted returns for our clients.
Something else that requires a comprehensive global response is – needless to say – safeguarding the sustainability of human civilisation. Next month sees the United Nations Climate Change Conference – COP26 – in Glasgow.
Over the past thirty years or so, the world’s most important governments have been meeting to thrash out important global issues. The stark reality of climate change will be high up on their agenda this year. The bleak message is that if we stand any chance at all of meeting those carbon reduction targets set by the Paris Agreement, then governments, companies and indeed all of us together are going to have to work hard over the coming years.
It’s no exaggeration to say that the financial markets have suffered some stress in recent weeks. Indeed, we could well see further weaknesses in the short term. Stock market returns in 2020 were simply incredible – on a par with those of 2009. While this year’s returns have been a little harder to secure, historically the second year of a new bull market has tended to perform fairly well. The end of the year could well bring with it a festive rally, meaning further gains before 2021 is out.
We may be facing a period of higher inflation and rising interest rates, but this is unlikely to kill off the current bull market. After such a strong economic and stock market recovery, valuations understandably look a little stretched in some parts of the world. And yet we still believe that exciting investment opportunities lie ahead.