With vaccine roll outs gathering pace, lockdowns easing and continued financial stimulus promised, it is understandable that the consensus now anticipates a strong recovery in demand and activity as the year progresses. As a result, year to date ‘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.
Corporate activity surveys from the United States (and elsewhere) covering both the manufacturing and services sectors underline the optimism felt concerning the scale of the forthcoming economic recovery. This feeling of optimism has been given additional impetus by government stimulus packages. Data highlighting the high level of savings that consumers have built up during COVID-19 induced lockdowns (and are likely to want to spend as confidence concerning employment prospects improves) underscore the potential for a robust recovery.
During the initial opening up phase, risk assets are likely to continue to do well. The recent equity market trends witnessed, whereby economically sensitive stocks outperform, is likely to continue with investors rotating their positions further into these areas as evidence of the strong recovery builds.
While the consensus can be correct for significant periods of time, being positioned ‘in’ the consensus is dangerous as the consensus can move suddenly, leaving the less nimble behind. Therefore, it is vitally important to be prepared and able to step away from the comfort blanket of the consensus, when circumstances dictate in the expectation that, in time, the consensus will then move towards your new position.
We are, therefore, closely monitoring numerous risks which could derail the consensus view of a strong 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’ policy of holding interest rates down at rock bottom levels. Developed market central banks may need to step in 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 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 cuts (car production being one example). Some sectors may struggle to fulfil demand expected by investors without increasing prices noticeably.
• Geopolitics: Tensions between China (and Russia) and the west are growing over a variety of different issues, any one of which could spill over and impact investor confidence.
While we are 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 markets will not have further to run. After all, it would be fairly perverse if markets went into reverse before any material opening up of the major developed economies had occurred.