We live in a fast-changing world. The investment landscape looked simple just a few months ago: the pandemic was receding, the economy was accelerating, and magic money from central banks and government was percolating everywhere. The picture was perfect, and investors were so enthusiastic that from stocks to cryptocurrencies, all asset classes were seeing record inflows.
Alas, a cohort of dark clouds invaded our blue sky from the late summer. Virus cases stopped falling, the economy stopped accelerating, inflation surged everywhere, not to mention idiosyncratic shocks like the Chinese real estate giant Evergrande melting down.
Is it a turning point in the global recovery? We doubt it, and here is why.
Let’s start with the virus. Yes, the delta variant is tough. The current run rate of global daily new cases is around 600,000, which compares to 350,000 in June. Some country data raises alarming questions: in the quasi fully vaccinated Israel, the daily cases per million people jumped from two in June to 1,000 in early-October.
Are vaccines ineffective? Well, they may not prevent infections in a reopening world, but when it comes to severity, they work. In Israel, less than 800 Covid patients are currently in hospital. In the entire UK, it’s less than 7,000, which compares to a peak of 35,000 during the third wave, when new cases were lower than now.
If vaccines are effective in reducing the pressure on healthcare systems, then the reopening is not at risk, we have just learnt to live with the virus.
Having said that, recent economic data has shown a deceleration, so that even the IMF mobilised its army of economists to issue a third update to their outlook (yes, forecasting is difficult), with the following insightful statement: “Global recovery continues, but the momentum has weakened and uncertainty has increased.”
It’s true, all major economic indicators from the summer were softer than expected, from consumption to manufacturing activities. However, data has been faster than the IMF. The latest releases were actually better than expected. September PMI indices, which are leading indicators of activity and signal contraction below 50 and expansion above, were as follows: the US is reaccelerating, above 60; Europe is strong at 55; China, which was below 50 in August, managed to come back to expansion territory at 51.
China’s trade numbers released last Wednesday confirm some softness in internal demand, with imports growing by only 10 percent year-on-year. However, exports increased by 20 percent – somebody somewhere is seriously buying stuff.
It doesn’t look like the global economy is on the brink of collapse. By the way, the IMF revised down their forecast for 2021 global growth by an astonishing -0.1 percent, from 6 percent to 5.9 percent. And their forecast for 2022 is unchanged at 4.9 percent.
Now it’s time to talk about inflation, and about the inevitable reduction of monetary support from central banks. Again, no doubt, economies reopen, pent-up demand is unleashed, and it meets a limited supply, affected by all the physical constraints imposed in the last 18 months.
This is particularly true for energy, where seasonality of demand adds to the perfect storm, but also for chips – even Apple could revise down their iPhone 13 shipments for Q4. The good news, however, is that even suppliers are reopening. It has started, and it’s only a matter of time that we’ll see capacity being adjusted.
The best evidence is in the job markets. Employers are struggling to hire, which is why September job creations disappointed in the US last month. In the UK, the number of people on payroll has just reached the pre pandemic level.
We thus keep on believing that price pressures are transitory. Ok, it’s arguably a long transition, as it takes more time to fix a physical supply chain than to solve an outage at Facebook. Still, stagflation is not a probable scenario. We see inflation as a byproduct of the current recovery.
Now, how will central banks react? First, the extraordinary levels of support currently in place are not justified anymore. The Fed made it clear that the pace of asset purchases will start being reduced from next month. Seeing rate hikes as early as 2022 is not to be excluded anymore.
Is it another threat to the economy? First, remember that they care. Any tightening is conditioned to a bright outlook. Second, they also care about markets. Their communication has made sure any bad surprise is avoided. Finally, but importantly, with the parabolic increase of public debt, virtually no developed country can afford high interest rates.
The age of magic money, where monetary and fiscal policies work together, could be here for very long, which would prove Ronald Reagan right when he once said: “Nothing lasts longer than a temporary government program.”
Don’t get me wrong, there are serious risks in the investment landscape; valuations are elevated and sentiment is vulnerable. There is no easy case. Every opportunity comes at the price of a risk – high yielding bonds in Asia are a good example of compelling medium-term prospects, bearing considerable short-term risk.
We expect volatility but as the economic outlook is not what keeps us up at night, we remain constructive for the quarters ahead. Stay safe.
Maurice Gravier, chief investment officer at Emirates NBD.
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