October Investment Summary
“Buying the dip” remains the correct strategy as markets rebounded sharply from the September selloff. The S&P 500 rose 7%, while the Nasdaq was up nearly 8%! There was no single reason for the rally. Rather it is the powerful and broad set of conditions that have been helping growth and boosting earnings and stock prices all year. Simply economic reopening combined with exceptionally accommodative monetary policy with some fiscal stimulus as well.
Despite flare-ups of the Delta variant of the Covid-19 virus, the reopening of most of the service economy around the world continues. While business travel hasn’t returned to its pre-Covid levels, leisure travel is picking up. Retail sales remain strong (albeit declining from their recent peaks), they are naturally shifting from goods to more services as consumers look to get out and about. Unemployment rates continue to decline as people return to work and wage growth, especially for the lowest income segment of the workforce, is rising at its fastest pace in years. Corporate earnings remain strong despite a few high-profile misses (Amazon and Apple) and warnings about the effect of supply chain issues and other cost pressures. So far there is not any effort to try and reign in this global expansion.
It is important to remember that the market sell-off of 2020 and the subsequent rebound were all driven by the pandemic and then the resultant government policy responses: namely lockdown and the concurrent shutdown of the service economy accompanied by enormous fiscal support and extremely accommodative monetary policy, and then the campaign to vaccinate the population and the resultant reopening of the service economy.
As the world economy returns to normal, the enormous fiscal support and extreme monetary accommodation will no longer be needed. The markets are already anticipating and trying to price these inevitable changes. This transition will not be smooth. No policy makers have faced anything like this before. Closing and then re-opening the world economy over 18 months has never happened before. Given this, gaging how quickly to remove the fiscal and monetary stimulus with the least disruption is impossible. Financial markets will overshoot, central bankers will make comments they regret and set goals they cannot meet. Just this past month we have seen yields on the Australian 2-year government
bond jump over 60 basis points in a few days as the Reserve Bank of Australia proved unable to continue to peg the yield at 10 basis points. Yields in most other developed markets have drifted higher this year despite no change in official rates.
The Federal Reserve have just announced their widely expected plan to reduce their pace of asset purchases by $15 billion a month, so that by end of June next year the asset purchase programme will have ended. But in their own words “Our decision today to begin tapering our asset purchases does not imply any direct signal regarding our interest rate policy. We continue to articulate a different and more stringent test for the economic conditions that would need to be met before raising the federal funds rate.”
So, when will they start raising rates? We don’t know and neither do they. Once the labour market has healed further or perhaps when inflation has stayed too high for too long? How high is too high and how long is too long? There is no clear answer to those questions. This challenge is faced by the other major central banks as well. The Bank of England just held off on hiking rates despite many comments suggesting that they would and markets generally expecting it. Divining the moves of central banks will prove more challenging for the markets and market participants. No doubt you have read about recent losses incurred by some big hedge funds speculating on the shapes of yield curves. It is difficult to predict what central banks will do when they don’t even know themselves.
We believe that the central banks are generally correct that much of the rise in inflation is temporary and a result of fall out from the pandemic in the way of shortages and supply chain disruptions that should dissipate next year. So, at present there is no need for central banks to urgently raise rates and throttle this post pandemic recovery in the name of fighting inflation. However, they also realise zero interest rates no longer make sense. Interest rate hikes are coming but the pace will be very slow and measured. Markets generally are not slow and measured. We stick to our view that markets will be more volatile than they have been over the first three quarters of this year.
We maintain our view the equity markets still offer the best opportunities again with emphasis on the Europe, the UK and Japan. We also suggest leaning toward companies that can control their costs and have pricing power.
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