• Inflation was centre stage last week with the core figure in the US just missing the 5% level. For once it was not higher than expected, and that was a bit of a relief. The other positive that was taken from it was the decline in the month-on-month rate i.e. we are passing the peak. • The Fed meets this week and the expectations are that it will announce accelerated tapering, with net buying to be completed by March next year, and that the ‘dot plot’ will be brought forward by a couple of quarters. Expectations have moved to a relatively aggressive statement from the Fed. Post the ‘Powell pivot’ of the week before last some of the investment banks have revised their interest rate forecasts. • As we approach year end the background remains equity friendly. Earnings are still being revised upwards. These have been acting as the perfect inflation hedge -as inflation has been accelerating in the second half of this year so has earnings growth. The Q4 reporting season will be kicking off in 4 weeks and the signs are that it will be another very strong quarter. In China the authorities are beginning to implement policy changes instead of just talking about them.
• The Powell pivot became the major talking point last week. During his testimony to Congress he said that the Fed does need to talk about a faster rate of tapering. He also pushed inflation concerns up the agenda. No doubt part of this was in response to the White House putting tackling inflation as a priority. As a result, there was a meaningful increase in interest rate expectations over the week. • The encouraging thing from last week was the reaction of the fixed income markets. Our fear has always been that as we moved towards normalising monetary policy, there could be a lot of volatility in the bond market which would undermine all asset classes (an interest rate scare). That did not happen last week. Yes, there is a bit of pain in the short end but longer dated yields fell and that is what is important to other asset classes. • Of course, Omicron is in the background and there is risk that its spread causes dislocation in the global economy. Perhaps this is what the bond market is thinking. One problem with this thinking is that if the dislocation does become significant then monetary tightening probably goes off the agenda. The Delta variant did cause some turbulence in the global economy and in equity markets but the growth rate remained high and the impact was short lived. Using that as the ‘playbook’ it says stick with your long-term strategy and that is what we will be doing and looking at last week’s reaction in the fixed income makes us a little bit more comfortable about that.
• Covid and the new variant will be the main focus in the short term. The reopening theme was already under pressure as infections were rising rapidly in Europe and this gained further momentum on Friday with some very extreme moves in prices. • This should not impact too much to views on asset positioning. Policy makers will remain very supportive, which is important, and the experience with the Delta variant has been quite benign. Friday was a shortened trading day in the US but the equity market it saw the second largest daily inflow this year from retail investors. • The equity mix is the more pertinent question and the hit to the reopening trade is a painful journey. But it seems like a lot of bad news has been priced in now so without some firmer information it would be difficult to add value reacting to the developments.• Last week we were still getting good indications on economic performance. The US is still leading. High frequency indicators (restaurant bookings, passenger traffic, credit card sales etc) were all back to new highs for this year. In fact, it looks like we are back into an upgrade cycle for the US economy although that should not last too long. There were also indications that China would start more efforts to support the economy Premier Li called on the provinces to step up infrastructure spending and the PBoC said it would be doing more to stabilise the credit market. The global economy looked set to have a quite strong finish. This was feeding into earnings as well. We are still getting upgrades, even in the euro area where the outlook has become most clouded. Earnings growth for 2021 was pushed up 1% over the last week. The environment remained very equity friendly.
• Covid became the story that the market was once again following closely last week, with a rise in infections in Europe. Reopening stories were under pressure and the return to normality for these companies looks likely to be impacted. The markets also saw the shift to quality within equity markets, which is due to how companies are managing the cost and supply pressures which they face.• Many Investment Banks are producing their outlooks for 2022, including Bank of America where it has turned aggressive on the timing of interest rate rises, with an interesting feature of it forecasts being the pace and the peak. It is expecting a 0.25% increase in Fed Funds per quarter and the peak to be between 2.0% and 2.25%, which can result in a benign interest rate cycle. There is not much expectations for downside left in fixed income markets and little disturbance for equity markets.• It was a better week for data with very encouraging figures from the US. Strong figures within retail and industrial production, as it could indicate that we are passing the worst in the impact of supply chain rigidities. It was a flat week for index levels, and this was the US statistics that came in strongly and will offset any turbulence in the EU area which will push us on into 2022.
• Economic data last week was dominated by the CPI release in the US showing continued inflationary pressure in the US economy. Market reaction was relatively muted. A lot of this relatively calm reaction is probably due to the Fed saying it will not be making any judgement about how permanent the inflation pressures are until the middle of next year.• We think that we will see a peaking in the year on year growth rate in the global economy as the reopening impulse fades in Europe and the US plateaus from its Delta variant rebound. As we travel into 2022 economic growth will remain elevated but at a slower pace than we are experiencing now. Thus, we feel it appropriate to move some more of our equity exposure to mid-cycle type names.
• Interest rate expectations faced a reversal last week, with two trigger points being the Bank of England meeting and the Fed’s Powell commentary on how transitory the inflation forces are. This pushes the expected interest rate increases in the US out towards Q4, which gave a spur to all asset markets.• Q3 earning season continued again last week, with US earnings growth coming in at 40% year on year, and in the Euro area, we are getting 50% year on year earnings growth. They are not as strong as they have been in previous quarters, which is coming from very strong sales growth. Companies are facing supply chain issues and cost pressures, however demand is very strong that they are able to cope with pressures and produce results. • This all leads to a positive outlook for the end of the year, which is motivated by the US economic performance, calm fixed income markets and an earnings story, with a potential for upgrades. The market may face disruption from China and closer to home via ongoing UK-EU negotiations.
• October was a very strong month for equity markets but there was a large regional bias. Developed Markets did far better than Emerging Markets. Some of this is due to the uncertain outlook for China both in terms of growth and policy and some of it is due to sporadic lockdowns due to the pandemic.• The most striking feature over the last week was the movement in longer dated bond yields in the US and the euro area. For maturities between zero and ten yields there was still upward pressure on yields but at maturities of 20 years and more yields declined by 15bps in both regions. This was driven by expectations of interest rate increase being brought forward into 2022 – we think this is too aggressive. • For equity markets it does re-enforce the need to be moving towards mid-cycle type exposure. While October was a month for cyclical exposure, that did fade during the last week and one saw the higher rated parts of the equity market beginning to perform, quicker than we would have expected. Last week reinforces the view that we should keep our portfolio preferences biased towards structural and sustainable growth (Healthcare, IT, Services, Consumer) and away from companies and industries that are reliant on the level of economic growth (such as Materials, Manufacturing).
• We got inflation updates from the US which were also somewhat encouraging. Both CPI and PPI came in below expectations. In the CPI report we did see some of what we hoped were transitory pressures (Travel and Lodging, second-hand car prices) subside. On the other hand, there is upward pressure on property costs which will be more sustainable. So, we are likely to have a higher level of inflation but not at some of the extreme levels we have seen in recent months. • China is a bit more mixed. Q3 GDP missed forecasts as did Industrial Production but much of this occurred in September as power outages spread. So, the weakness is not due to lack of demand. On a positive note, Retail Sales accelerated in September as the number of lockdowns declined. • The reporting season will capture more of the headlines over the next few weeks and the start has been promising. The consensus forecast is that Q3 earnings for the S&P 500 will be up 30% YoY, 11% higher than at the start of the year. Even over the last four weeks this was increased by 1.6%. • What we have seen over the last week supports our positioning, a strong growth background with easing in inflation pressures translating into very strong earnings growth. Equities benefit and bonds remain reasonably well behaved. What could derail it is the rampant energy prices and power supply issues. Governments seem alert to the potential growth impact so policies will be implemented to alleviate income pressure from the higher prices. Supply response has been muted so far but that could change and normally does.
• The third quarter was more subdued than the previous ones. Equities ended the quarter on a weak note, but still eked out a small positive return for the full quarter. Bond markets also had a tougher end to the quarter delivering a flat performance for the overall.• This quarter was the first this year where GDP forecasts for 2021 were reduced. Global GDP growth was cut from 6.0% to 5.7% driven by cuts to US and Asian forecasts as the Delta variant impacted on consumption and production in Asia. Profit expectations remained robust with 2021 earnings growth increased from 39% to 48%. Europe saw the biggest upgrades and by sector it was again Industrials, Energy and Materials that led the way.• Some of the factors dragging on markets in late Q3 are likely to reverse or have less of an influence through Q4. Rampant energy prices could undermine this and this remains a concern but any easing in energy prices here would clearly be a major positive.
• There were three issues on peoples mind coming to the end of the quarter; the main issue being the Fed’s announcement in November about the tapering time table. This has driven bond yields up and 10-year yields to rise between 10 and 20 basis points, putting pressure on equity markets. Both the fixed income and equity markets have been unsettled with China’s Evergrande, would it cause financial contagion? Lastly the spike in energy and power prices has fuelled the inflation pressure around the globe. • Asset prices are lower, previously there was possibly an element of complacency. Other developments have made us more comfortable. If we travel back to August, we would have worried about the Delta variant disrupting economics, however the releases for September show the Chinese and Asia X China PMI’s back at or above 50, moving back to expansion territory. In the US, a strong Manufacturing ISM and improvement in data such as restaurant bookings and credit card transactions shows the with the economic background looks better than the previous month. The Q3 reporting season should give some support as sentiment is fairly low at present • Portfolio strategy remains overweight equities as economic expansion in place. News of the Delta variant slowing and news of a possible oral antiviral treatment gives another boost to the reopening. Developments have been positive and support an equity orientation asset allocation.
• Last week’s US Federal Reserve Fed meeting saw Powell signal that tapering of bond purchases is likely to be announced around November, with net purchases set to cease in the middle of 2022. A first interest rate hike in the US in the fourth quarter of 2022 is now in line with half of the Fed participants. US treasury bonds were initially unmoved but increased supply and a likely rate hike by the Bank of England in the 4th quarter led government bond yields higher.• Economic data releases confirmed an expanding economy but decelerating from the prior high levels. Preliminary purchasing managers indices, a business sentiment survey, in the US showed continuing strong growth, especially in manufacturing, but modestly weaker than last month’s level. In the Euro area, both manufacturing and services preliminary purchasing managers indices are signalling strong growth, but noticeably lower than last month.• Our asset allocation view remains overweight equity – supported by reasonable forward valuations and positive earnings growth and underweight fixed income – focusing on shorter maturities and corporate bond exposures.
• Latest US economic datapoints suggest the US consumer and manufacturing sectors are in good shape. There have been Covid related disruptions, but these should moderate similar to prior waves. • The US Federal Reserve will meet this week. The US Federal Reserve will provide an updated economic outlook, now extending into 2024, and may announce when it will begin tapering its pandemic emergency asset purchase program (which provides liquidity and keeps interest rates lower than they might be otherwise), giving the market advance notice. The announcement on tapering could be pushed out to November, but would then remain a key risk. The pace of tapering may be indicated. Markets will focus on how quickly the Fed may expect to raise interest rates but the expectations are the members’ outlooks, not a Fed forecast and remain subject to change. • While the peak rate of global economic growth (off of the low pandemic base) may be in the rear view mirror, and monetary policy seems set to downshift, the growth outlook remains above trend as economies are recovering from Covid and restrictive measures are gradually removed.
• Equity markets were softer whilst sovereign bond yields rose slightly last week. No specific driver for these moves, however concerns on economic growth, reduction in central bank supports, higher inflation expectations and state intervention in China were factors. Fixed income weakness likely to have been driven by significant pick up in supply in both sovereign and corporate bond markets as primary market reopened after the summer. • The Goodbody asset allocation team met last week and decided to increase exposure to US short duration as an attractive risk return profile relative to cash. The committee also expect lower growth levels but remain positive. Global growth forecasts look to have peaked at a high level and momentum has slowed in response to delta variant and supply side shortages. Momentum and forward looking indicators have slowed recently. • The team expects inflation pick up to be transitory. Spike in inflation due to year on year effects and supply side constraints. Labour demand continuing to outstrip supply, which should ease as economies reopen and financial supports are reduced. Inflation expectations have risen in US and in particular Europe. We expect inflation to be transitory, however, expected to settle at higher levels than seen in the past 5 years.
• Latest economic datapoints reflect a weaker growth narrative that is getting louder among financial participants. In the US, latest consumer confidence and retail sales were weak, and the latest jobs report for August indicated much lower job creation than expected in the month. In China, manufacturing and service data also came in weaker than expected. Not surprisingly, markets have responded in a defensive fashion, with cyclicals no longer outperforming defensives in recent weeks. This continued last week.• However, a deeper look at the data tells us a different story. The August US ISM Manufacturing survey – generally a strong leading indicator - was higher than last month and beat expectations, with new orders and inventories up. And the report spoke about how supply chain bottlenecks are impacting the economy. We see these problems as transitory, not structural. • We have already responded to the slower pace of growth by reducing our equity exposure last month, but we remain positive about continuing growth. Our recent additions in Financials and Industrials reflect this, and we are looking at Consumer as well. As the vaccination rollout continues, we think the Delta wave passes and indeed may have already peaked. Income levels still remain well above spending levels and the Central Banks are not tightening policy anytime soon.
• The first thing to understand is President Xi’s policy goal of common prosperity - he wants to reduce inequality across China. He’s also extremely concerned about the low birth rate in the country - despite reversing that one child policy in 2016, the birth rate has continued to move lower. Both of these issues are linked and they also have serious implications for the private education sector and the internet sector.• The net effect is a less friendly investment environment - internet stocks will face increased regulation, higher costs, lower returns on invested capital and for the companies that are not focused on the areas that China views as strategically important, it means making more investment in these areas or if not, then making donations to state-backed initiatives that are focused on these areas. • We’ll be watching the region closely but for the time-being we’re happy to stick with our position given the heightened uncertainty, regarding earnings, valuation and sentiment.
• We had tremors across equity markets as a something of a ‘growth tantrum’ hit us. The cause was Retail Sales figures missed in a few countries. Some of this would be due to consumption switching over to services and away from goods but the spreading of the Delta variant undoubtedly is having an impact as well. One important thing to bear in mind is that even though the figures may be coming in below forecast, the level is still very high. But it does show what can happen to market sentiment as we transition from the recovery phase of the cycle into the expansion phase (growth rate still above trend but decelerating). This supports what we have been doing in portfolios. Resetting the equity exposure to where we were at the start of the year, returns will be more muted going forward. But remaining overweight equities, the growth rate is still strong. Moving more into companies and sectors with more dependable growth, with less reliance on the cycle.• What was encouraging last week was the performance of the bond markets. There was a big ramp up in discussion about tapering last week and the potential for an earlier than expected arrival of it. But bond yields declined slightly during the week. They were undoubtedly helped by the growth fears that pushed through markets but still it was a very resilient performance. For us that is encouraging. We knew that as the recovery gained traction the emergency monetary measures would have to be removed. We thought this would put fixed income markets under pressure but that they would remain orderly. This seems to be the way they are behaving.• Developments in China grabbed a lot of attention during the week and continue to undermine Emerging Markets and Asia Pacific in particular. Month to date, MSCI Asia Pacific ex Japan is down 7% in $US terms against the world which is up slightly.
• One of the factors driving the recent growth scare was the prospect of passing the peak in growth rates. The ISM Manufacturing Index is one of the indicators that is closely followed as an indicator of the health of the US. It does appear to be peaking now. Some people would say that if the growth rate is peaking then that is bad for equity markets. We do not agree. Looking at data for the past 30 years, the equity market has continued to move ahead in periods following an ISM peak. More specifically, if we look at periods when the ISM has recovered from below 50 and then peaks but still remains above 50 (i.e. the economy remains in expansion) the S&P 500 was up in all them. The average return in these ‘past the peak but still in recovery’ phases was over 30% (worth pointing out the average period here lasted 3 years). So the peaking is not the important thing – it is whether we remain in expansion after. Consensus forecasts indicate that not only will we be in expansion mode it will be well above trend.• An interesting feature of the recent turnaround was the source of flows on the recovery day. Retail investors accounted for nearly 90% of activity on the New York stock exchange on Tuesday. This is the second time in less than two months that a very weak down in the US market has sparked retail buying. We had been wary of the argument that post a strong start to the year there was potential for a correction along the way. We acknowledged that this could happen but felt that it was unlikely to be large enough to be able to add any value positioning for it. The performance around the two recent scares re-enforces that. The ‘buy the dip’ mentality is strong and it has fire power.• The result season has got off to a very strong start. It looks like it will be close to a record season again. The standout so far has been the changes to guidance. Close to 90% of companies that have reported so far have improved their outlook. There was a chance that we could have good second quarter results but that companies could make cautious outlook statements due to rising input costs or supply chain issues. This not turning out to be the case and earnings should provide strong support for further advances in equity markets.
• There was another big CPI figure in the US accelerating on a MoM and YoY basis but curiously the bond market barely fluttered. But as we were saying last week the growth outlook was capturing more attention than the inflation outlook.• Could it turn grim? We expect the economic momentum to fade but remain well above trend. Last week we did see some glimpses to support that. Firstly China, leading the global recovery and leading the fade. In the Q2 GDP report, released last week, annualised growth was 7.9%, below the 8.5% forecast for the year but the June releases in it (Retail Sales and Industrial Production) showed strong rebounds. The growth rate may be fading but stabilising at a relatively high rate.• Pulling all this together we have elevated inflation which still looks like it will subside and anyway central banks do not seem alarmed by it. Hence although we would expect yields to rise in the fixed income markets, they are likely to remain orderly. There are a lot of signs of slowing momentum in the global economy, but the growth rate remains high which will continue to drive strong earnings growth and thus the environment remains equity friendly and it remains the asset class of choice.
• The market has moved rapidly from worrying about an overheating global economy sparking off an inflation spiral to a peak in economic momentum starting off a significant slowdown, with 10-year yields in the US dropping below 1.3%. We agree that economic (and earnings) momentum will start to decline (i.e. the rate of increase will start to subside), but growth will still be well above trend. • Unusual for this stage of the cycle, it is going to get further fiscal support from the Recovery Plan in the euro area and the potential for an infrastructure bill in the US. • There was nothing through the week suggesting we should alter our course. Growth fears are over-done, if that is what is driving bond yields down. We must remember that bond markets are somewhat distorted by the large presence of central banks and negative interest rates across many parts of the globe. The change in Chinese policy reminds us that authorities everywhere are very mindful of not letting economies slip backwards especially with the Delta variant spreading. We have been positioning for a fading in growth rates but still an above trend growth rate along with the withdrawal of the emergency elements of monetary policy. Nothing has happened to change that position.