The middle of the year is always a good time to reflect on what has happened, take stock, and think about positioning for the foreseeable future. Market sentiment has been shifting this year with an overall rotation out of growth and into value assets, which has caught many managers off-guard. This has been prompted by two key factors:
1. Progressive steps by governmental bodies to roll out Covid 19 vaccines, moving towards a reopening of the global economy
2. Fiscal and monetary stimulus by local authorities supporting financial assets
The combined effect of these has prompted markets to price in the prospect of inflation, with markets now expecting policy makers to scale back their efforts ahead of schedule, to keep the reigns on runaway inflation.
Initial signs of price pressure has been seen from both a cost push and demand pull perspective: The UK annual rate of inflation more than doubled in May to 2.1%, its highest level since the start of the coronavirus pandemic, following higher petrol prices and gas and electricity bills, whilst pent up demand from consumers is expected to flood the economy as too much money continues to chase too few goods.
The question remains, however, as to what extent we will see these inflationary pressures. Transitory effects may be either a short term acceleration to the upside, or indeed reverse to the downside, versus a more prolonged continued acceleration.
Despite the top expectations for inflation, beneath the surface, not all is plain sailing. Clearly there are some ‘hotspot’ areas (retail, flights, petrol), global growth from the IMF is anticipated to be around 7% this year (the fastest pace in a generation), as well as non farm job creation coming in at 850,00, much higher than the anticipated estimates of 720,000. There, however, needs to be evidence of further signs of more widespread and consistent price support. There are still significant levels of economic slack – an obvious example of this can be seen in the number of unused desks within office blocks, and whether we will see a return to pre pandemic normality, or indeed an alternative use of this space. Local high streets are a changing landscape, not only for small businesses but larger brand names and also rethinking their strategy.
The credibility of central banks is starting to come under some pressure. Jay Powell has taken an about turn now ‘talking about talking about’ tapering the $120bn per month asset buying programme, with the Fed dot plot matrix showing appetite for two rate hikes towards in 2023. Equity markets have lapped this up, continuing to push new highs, however the bond market is telling a somewhat different story and 10 year treasury yields are no longer on the upwards trajectory that many envisaged, but rather pointing to a ‘middle’ or ‘bottom’ growth environment going forwards.
Ultimately expected inflation is positive for debtors and negative for creditors, albeit bonds allow for the uncertainty factor, or indeed a shock to the reopening of the economy trade.
Policy makers will need to take a cautious approach, spinning the inflation, growth and employment plates using the tools at their disposal in order to avoid a hotspot.
As we continue through a year of transition, having a balanced business outlook is key to ensure exposure to multiple areas of the market, maintaining a diversified approach, whilst remaining uncertainty aware. This is the optimal way for businesses to strike it lucky!
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