In this month’s strategy piece Alastair believes that the economic cycle continues to evolve and investors should position portfolios accordingly. The advent of mass COVID-19 vaccination programmes in developed nations combined with enormous monetary and stimulus packages have created the conditions for a sharp closing of output gaps and a slower pace of GDP growth should now be expected. Purchasing managers’ indices (PMI) have peaked over the summer in both Europe and the United States. Financial markets are contending with both fiscal and monetary headwinds. Developed market fiscal policy will be progressively tightened during 2022 having remained loose for the duration of 2021 at the same time as monetary policy is tightened.
Market volatility has risen in recent weeks as policymakers negotiate their first steps away from COVID-19 support towards more neutral settings. Rising earnings forecasts for 2021 have been the fundamental support behind the market rally. However, during the past month momentum in profits forecasts has come to a near-standstill with many global sectors seeing no increase in forecasts. Inflation and inflation uncertainty are key to the outlook for asset prices. With the notable exception of Japan, developed market core consumer price indices have surged above long-term trends. Anecdotal evidence of shortages has become endemic, affecting industries as diverse as shipping, semiconductors and agriculture. Rising survey based inflation will need to be reconciled with currently benign market-implied inflation measures.
Equity investors may be of the view that they are they are partially hedged against higher inflation as equity represents a claim on the nominal future profits stream. This is true but should not give rise to complacency. At times of high inflation equity valuations have historically tended to suffer from higher inflation uncertainty, which increases the required rate of return due to an increase in the equity risk premium. Since last month we have moved to a cautious position on global equities as high valuations are now inconsistent with evidence of a slowing of economic momentum and the imminent prospect of tighter monetary conditions. On a global basis both corporate credit spreads and our estimate of the global equity risk premium are close to 17-year lows.Download PDF