The quote attributed to the American writer, Mark Twain: “I am an old man and have known a great many troubles, but most of them never happened” is a perfect fit for where we are at the moment, as financial markets have a great many ‘troubles’ that – we believe – will never happen.
By far the biggest ‘trouble’ we have seen over the valuation period is stagflation.
There has been a growing drumbeat of speculation that the strong recovery in demand, as coronavirus lockdowns continue to be lifted alongside the current supply chain bottlenecks, is going to result in stagflation.
We believe the use of the word is well over the top: it is inflation, not stagflation.
Although we accept that year-on-year inflation readings over the past couple of months have accelerated quickly, the largest upward contribution to this change is due to what is known as the ‘base effect’ thanks to last year’s coronavirus distorted prices.
For example, inflation is always calculated and expressed as a percentage change compared to prices 12 months ago – and thanks to a mixture of OPEC supply cuts and a more optimistic economic outlook, the price of a barrel of Brent crude has risen very strongly following its dramatic collapse last April.
Likewise, the current price of a litre of unleaded petrol is nearly 140p. We believe this means we will continue to see the impact on prices for several more months, before quickly falling back towards central bank targets during next year.
This is a far cry from being stagflation and we don’t believe that inflation is going to be high enough, or sustainable enough, to prompt policymakers to significantly increase interest rates. We believe concerns are overblown and as such, it is important not to get sucked into the negative news headlines surrounding stagflation.
Looking ahead, the final quarter of 2021 is set to be just as eventful as the third quarter thanks to: US political wrangling over the US debt ceiling and Joe Biden’s proposed infrastructure spending plans; the US central bank is almost certain to start tapering its QE program; and we have the ongoing Evergrande story. Additionally, there will be new government leaders in Japan and Germany to add to the political uncertainty.
But again, while the media will no doubt magnify the dangers, we believe many of these ‘troubles’, will come to nothing. For example, while the Evergrande situation remains fluid, we fully expect that Beijing will step in to prevent any contagion since much of China’s wealth and economic growth is tied to property. Likewise, Fed tapering will likely be slow and certainly won’t be an abrupt stop, let alone a reversal of QE (i.e. selling the bonds the Fed has previously purchased). And more importantly, simply because the Fed is likely to taper its QE program does necessarily mean US interest rates are going to rise anytime soon. In fact, we aren’t expecting any US interest rates increases in the next 12 months – and that is great news for global equity markets.
Additionally, financial markets are currently pricing-in the prospect of the Bank of England increasing interest rates three times over the next 12 months to stem the UK’s inflation, which we believe is far too aggressive. We find it difficult to see a scenario where it needs to raise interest rates twice more in the same year, especially given the uplift in Universal Credit ends today, coupled with next year’s planned increase in National Insurance rates.
In fact, we believe interest rates are unlikely to go significantly higher than they are today – and when they do arise, the increases will be measured and gradual.
For a bit more detail on the matters raised, please refer to your latest valuation statement.
Investment Management