Equity Strategy: Awkward Adolescence

Feature Stories | Oct 07 2021

While the pace of the global economic recovery has slowed, the next step is another move out of covid-driven restrictions. What is the path from here for global and Australian equity markets?

-Slower pace, bumpier road ahead for global economy
-Chinese policy a significant risk
-Equity market rotation back on the cards
-Inflation possibly the biggest risk

By Greg Peel

“The post-lockdown recovery has transitioned from energetic youthfulness to awkward adolescence,” suggests Russell Investments. “It’s still growing, although at a slower pace”.

When the world went into lockdown last year, global equity markets were already bouncing hard out of March’s covid-crash depths, as investors sought to take advantage of panic-driven oversold conditions. By July, the S&P500 had recovered all losses.

The gains were driven by the stay-at-home theme, for which technology is the dominant factor. The surge in online shopping, video streaming subscriptions, video-conferencing, work-from-home equipment and even home delivery meal services provided strong tailwinds for both the technology sectors and traditional businesses with established tech capacity, such as online retail.

Technology-based sectors dominate the S&P500, and Big Tech names dominate technology. While many Australian companies were also able to ride the stay-at-home wave, the locked-down Australian economy wallowed amidst weak commodity prices. It was not until April this year that the ASX200 recovered March 2020 losses.

When last year’s lockdowns ended, it appeared the developed world had covid under control. Having been the first to enter lockdowns, China was also the first out, and the resumption of demand drove a swift rebound in commodity prices, most notably iron ore, but also oil.

When Moderna and Pfizer announced they had produced vaccines in November, global equity markets took off again. The announcement also happened to coincide with Joe Biden’s presidential win, endorsed or accepted by Americans of intelligence.

Economies were surging out of their depths faster than anyone had foreseen, and vaccine faith managed to offset an even more substantial wave of US covid cases into the new year. This was, as Russell Investments describes it, the post-lockdown recovery’s “energetic youthfulness” phase.

Then along came delta.

Aside from a bit of a breather from April through to June, the S&P500 took delta in its stride, as the vaccination rollout moved into overdrive. But what delta did achieve was to heavily impact the supply-side of global economies. This led to slower growth and, most notably, inflation spikes, as shortages of wholesale goods and labour made their impact.

And today, continue to make their impact.

The Great Debate

The great inflation debate centres not specifically on whether inflation spikes are “transitory”, as transitory has no definition in time, but on whether having peaked, inflation settles back to pre-pandemic levels or to a structurally higher level.

Mathematically, monthly annual measures of inflation must ease as each month cycles away from the deflation brought about by last year’s lockdowns and towards the ensuing months of economic recovery. Hence no one is suggesting current elevated levels are here to stay.

It is Russell Investments’ view US inflation may remain high over the rest of 2021 but decline in early 2022. The fund manager’s models suggest inflation is likely to drop back below the Fed’s 2% target in 2022 which implies, if accurate, the Fed is unlikely to make its first rate hike before the second half of 2023.

The Fed’s announced tapering program surprised the market by its pace, to be completed by mid-2022 with December assumed as the starting date, but did not lead to an expected “taper tantrum”. It was the Fed’s post-GFC policy that gave the world the “taper tantrum”, yet back in 2015 the timing to completion was almost twice as long as the Chair is proposing this time.

The lack of tantrum can be put down to many in the market believing tapering should already be underway, given the pace of economic recovery. But Wall Street did perceive a hawkish shift in Fed rhetoric, backed up by nine FOMC members forecasting the first rate hike in 2022.

It is that first announced rate hike, most believe, that will spark a true tantrum.

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