July Investment Summary
World equity markets, excluding China, had another month of strong positive performance. Corporate earnings releases covering the second quarter of 2021 were generally very good, often exceeding already high expectations. Company profit margins also remain high, especially in the tech sector, despite higher input costs.
There were concerns mid-month about the virulence of the Delta variant of Covid-19, that perhaps its spread would halt re-openings and possibly bring back restrictions on activity and threaten growth. Coincident with this were rising fears that inflation would remain high, provoking the central banks to tighten their policies. The June inflation data for the US showed headline inflation at 5.4%, the highest since 2008 (when oil was nearly $150 a barrel.) Equity markets wobbled for a few days. These fears proved transitory as the yield on the benchmark US ten-year maturity government bond fell below 1.2% and equity markets sharply recovered.
It was a very different story in the Chinese markets where new heavy handed and unexpected (to some) regulations on the activities of the large Chinese tech firms were announced. Those companies with listings outside of China were particularly hard hit. Huge mega cap firms such as Tencent, Alibaba and Baidu saw their share prices down as much as 20% intra month. Just as markets stabilised, new restrictions were announced on the large for-profit education and tutoring companies, which essentially terminated their for-profit status. This was disastrous for their share prices. These new rules come from the very top levels of the Chinese government, which under President Xi look to reign in some of the free-wheeling capitalist behaviour of their tech sector and the many billionaires it has spawned. The government has announced that further restrictions and rules will be forthcoming. It is hard to see Chinese equities outperforming with this backdrop.
The Federal Reserve, the ECB and the Bank of England have all recently held meetings, delivering a consistent message across the board. Economies are doing better as vaccinations and reopening of activity take place. Inflation is currently above target, but this is a transitory phenomenon because of temporary supply disruptions and base effects in the inflation calculations. Monetary policy will remain accommodative to ensure a continued recovery from the pandemic (along with ongoing support from fiscal policy) and to ensure that longer-term inflation goals will be met. All the major central banks have adopted asymmetric inflation targeting, meaning that inflation slightly above 2% for a few years is allowed as it will make up for the many years of inflation running below target. These central banks continue to assert that should the rise in inflation prove to be more permanent, then they would take appropriate action. Talk is cheaper than action and this remains to be seen. The next move by central banks will be to modestly reduce the scale of their asset purchases, so they will be tightening policy but in no way will policy become “tight”. It is possible we could see an announcement from the Federal Reserve before year end outlining their planned reduction in asset purchases.
The spread of the much more contagious Delta variant Covid-19 and its effect on activity is the hardest factor to evaluate. In countries with a large percentage of the population vaccinated there appears to be limited appetite for the re-imposition of lockdowns or serious restrictions on activity. If one looks at the UK as a template, as it was the first nation to see a surge in infections from this variant, then the signs are encouraging. While there was a sharp spike in infections there was not a commensurate surge in hospitalisations and deaths. Let’s hope this is the correct model for the rest of the vaccinated world. China is taking harsher actions now that the Delta variant has shown up there, and it is unclear how significant an impact on economic activity their actions will have.
In summary, we remain comfortable that the combination of very accommodative monetary policy and stimulative fiscal policies along with the ongoing reopening of activity and further progress in vaccinations will support growth and corporate earnings. This should continue to boost equity markets. Fixed income will periodically be troubled by the persistence of higher “transitory” inflation numbers, and we would hold minimal exposure here. We expect further catch up from UK and European markets relative to the US.
Jeffrey Brummette
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