With vaccine roll outs gathering pace, lockdowns easing and continued monetary and fiscal stimulus promised, it is understandable that the consensus now anticipates a strong recovery in demand and activity as the year progresses. As a result, during the first calendar quarter of 2021, ‘safe haven’ assets such as developed economy government bonds and gold were sold. Conversely, commodities (such as oil and copper) and stocks which tend to do well when global economic activity is accelerating (such as banks, insurance and industrials) outperformed.
Data highlighting the high level of savings that consumers have built up over the past 12 months (and are likely to want to spend as confidence concerning employment prospects improves) underscore the potential for a robust recovery. An added bonus is the wealth effect experienced by those consumers that have assets linked to either the rising stock market or house prices. This data suggests a very strong economic recovery is now on the cards as we progress towards the northern hemisphere’s summer.
During the initial opening up phase, risk assets are likely to continue to do well and the recent equity market trends witnessed, whereby economically sensitive stocks continue to perform strongly, is likely to persist as investors rotate their positions further into these areas with evidence of the strong recovery building. There are, however, numerous risks which could derail the consensus view of a strong and unfettered global economic and earnings recovery. Some of these risks are as follows:
- Renewed lockdowns in the autumn: Although the European vaccination program is likely to catch up over the summer, renewed lockdowns this coming autumn and winter can’t yet be ruled out, either due to new variants emerging or simply that there remains too many cases of COVID-19 circulating in the population.
- Monetary policy: At some stage, investors are likely to challenge central banks to act to prevent government bond yields rising to levels which could impair faith in the recovery, as higher refinancing costs linked to increased levels of debt might result in higher defaults, a stalled housing market and, by extension, a reduction in confidence and activity.
- Fiscal austerity: Currently, investors are focussed on the spending packages designed to return economies back to growth, but at some stage investors will need to start to think about the ramifications of when this fiscal largesse will come to an end and how the enormous government fiscal deficits will be brought back under control.
- Inflation: Business and consumer demand is rising. Business inventories are low and transportation costs are high. Evidence of a shortage of some materials (such as semi-conductor chips and packaging) is beginning to show up as price rises and production curtailments (car production being one example). Some sectors may struggle to fulfil demand at the margins expected by investors without increasing prices noticeably.
While we’re beginning to see a few warning signs of excesses in some areas of the market coming home to roost (examples include the collapse of the hedge fund, Archegos, and the specialist credit provider, Greensill Capital), it is difficult to conclude that the reopening trade will not have further to run. After all, it would be fairly perverse if the reflation trade went into reverse before any material opening up of the major developed economies had occurred.