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At the start of November 2020 I was expecting “a winter of discontent” due to rising COVID numbers, the return to national lockdowns in some countries, reducing economic activity, how central banks were continuing with their ultra-loose monetary policy and in markets, and why bonds and the FAANGs (Facebook, Apple, Amazon, Netflix, Google) had remained in favour with investors. All in all, not a great outlook in the short term.
However, less than four weeks later, I considered that ’maybe spring is arriving early”. How quickly things can change! Pfizer / BioNTech had announced that their COVID vaccine was showing high efficacy and this was rapidly backed up by similar announcements from other vaccine producers. The outlook had changed dramatically in the space of a few days and inevitably asset prices moved quickly; bonds yields jumped, gold fell and equity markets moved higher, this time not driven by the FAANGs, but by companies sensitive to economic conditions. The moves were sharp, to give examples of that, although maybe extreme ones, the price of Zoom fell from US$500 to US$370 whilst Carnival Cruises rose from US$14 to US$19. The trend was seen through and across the market overall.
However, in the face of the good news, the economic backdrop remained less positive; US jobless claims were rising and UK national debt had risen to £2.08 trillion, the equivalent to 100.8% of GDP, the highest level since 1960, when we were still paying off the debt incurred as a result of World War II.
So much has happened since then. It is hard to believe that from the Pfizer announcement to the time of writing this, nearly 12 months later, the vaccination programmes have given nearly 7 billion shots worldwide, according to the Bloomberg Vaccine Tracker.
I think that was worth a look back, after all.
When I sat down to write this, I did promise myself it would not become dominated by tales of supply chain shortages and inflationary pressures. So, let me get that out of the way.
The supply chain shortages are real and they are significant. They, themselves, will drive prices up and feed inflation. Inflation is here and will stay for some time, certainly for the medium term, before we see signs of it abating. The European Central Bank has admitted it will last longer than it has been anticipating. However, if it does not get worse than currently expected, it is reasonable to think that central banks will be able to take measures to mitigate the risks of it getting out of control.
Interestingly, the supply chain shortages and price increases will themselves dampen economic activity and therefore inflation.
Economic growth is disappointing in many major countries, including the US, where third quarter growth was 2%, less than the expected 2.6%, although consumer spending and the labour market are good, which is important. In China, the world’s second largest economy, growth is under pressure as well. The economy grew 4.9% in the third quarter from a year earlier, but that was down from 7.9% in the previous 3 months.
We are in a rather unusual position of seeing the rate of economic growth slowing at the same time as inflation is rising sharply. The policies adopted by central banks in dealing with this are going to be crucial to the outcome.
Financial markets will react to news flow and changing expectations. For now, if there are upside surprises to inflation, then we are likely to see bond markets suffer and increasingly stock markets will come under threat. If the opposite is true then asset prices should prosper. I am not about to predict what will happen to inflation, but I am of the view that central banks have managed their economies well through the pandemic and I would back them to continue to do so.
There, failed in my attempt not to give inflation centre stage.
The company results announcement season always brings a feeling of expectation. We are in the midst of the third quarter season now and there have been fears that companies will be warning that the supply chain shortages and price increases that are abounding will dampen profits growth for the last two months of this year and also next year. There have been some signs of this, but nothing serious enough to worry investors overall.
In fact, the results for the third quarter have been good; Microsoft and Alphabet (Google’s corporate name) announced very good results, driven by growth in their cloud computing businesses. These were given a boost by the changing life and work patterns driven by the pandemic, but they are here to stay. Coca-Cola and Mcdonald’s produced better numbers than expected, so did Caterpillar, the construction equipment company, although they did warn about supply chain issues. GlaxoSmithKline, the pharmaceuticals company also did well, as did much of the financial sector.
Clearly, it has not been all good news, but overall profits have remained robust, which will support stockmarkets. Two exceptions have been Amazon and Apple, which are fairly important in the overall scheme of things. Amazon announced disappointing sales and profits numbers for the third quarter and indicated that the fourth quarter will disappoint as well, citing supply chain and staffing problems. Apple, meanwhile, announced sales figures that were, as usual, very high. Total revenue was $83.4 billion, up 29% from the same period a year ago. It was only disappointing because they did not meet consensus expectations of $84.9 billion due to component shortages; some disappointment. But, that is how markets work.
Overall, the prices of assets such as bonds and company shares reflect the future rather than the past, both have been reacting to expected inflation and interest rate increases. How that plays out will be the key to the rest of this year, but more particularly 2022.
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