Through the third quarter, 6.2 billion Covid-19 vaccines have been administered globally, taking the share of population who are fully vaccinated to 33% from 8.1% and those receiving one dose to 45% from 23%. We expected a level of fear and uncertainty through the transition out of lockdowns and indeed the third quarter was characterised by concern that the delta variant may stall economic recovery. Despite some delay, lockdown restrictions continue to be lifted and international travel is becoming more viable and widespread. The result has been a surge in active cases, but we now have strong evidence that the vaccines (Pfizer, Astrazeneca, Moderna, Johnson & Johnson) are highly effective at preventing severe symptoms and death; this includes the delta variant and hopefully will include other new variants. The higher incidence of virus severity in the US is attributable to a larger cohort of the vaccine averse.
Inflation & Central Banks
Global coronavirus cases have been rolling over since August and focus is shifting to other risks. Inflation has spiked as economies emerge from the pandemic. If inflation runs too high for too long, Central Banks may respond by tightening policy. This will push up bond yields and has the potential knock-on impact of reducing the relative value of riskier assets, with growth stocks particularly susceptible. Until now, Central Banks have been sanguine, viewing the current spike as transitory while the global economy endures a structural change before the economy normalises.
In recent days, however, we have seen a sharp upward shift in US & European government bond yields, reversing their fall since May. There is now a looming energy crisis, with China imposing rationing on its industry and a spike in UK energy prices that threaten to push inflation to double the BoE’s 2% target by year-end. Brazil’s crops have been ravaged by drought and frost which is pushing soft commodity prices higher, shipping costs remain high and supply chain bottlenecks persist. An extended period of above target inflation may test Central Banks’ resolve and this comes at a time when investors are already weighing up the pace and impact of Federal Reserve tapering. The silver lining may be unemployment rates which remain above pre-pandemic levels and could buffer inflationary pressures.
The pace of economic growth has started to slow in most countries around the world following the sharp V-shaped recovery earlier this year, but a slowing economy does not mean a stalling economy. Consumers still have healthy bank balances and sentiment is broadly improving. Corporate inventories are at record lows and we could enter a period of rapid industrial production growth as these normalise – supply chain issues permitting. Mid-cycle equity returns have historically been lower than during a recovery but are respectable nevertheless, typically driven by continued earnings growth.
Developed market equities have performed well over the third quarter with the US up 1.9%, Europe 0.8% and the UK 2.2%. Having trailed in its vaccination program, Japan has managed to double dose 60% of its population from virtually zero in May; as a result of this and the resignation of the prime minister Yoshihide Suga in September, Japanese equities have risen 3.2%. In a dramatic shift, the US dollar surged in the final days of the quarter while sterling weakened as the UK approaches the end of its furlough scheme while grappling with a series of economic difficulties. In comparable currency terms, the best performing equity markets were the US and Japan.
China has had a difficult quarter. Thriving on the demand for construction and manufactured goods since the onset of the pandemic there are concerns the economy could slow as western economies normalise. Evergrande, one of the country’s largest property developers, has been defaulting on its debt payments. Despite huge levels of debt, the company has equally large levels of property assets, so we don’t expect wider contagion, but it has brought into question the notoriously hot Chinese property market. Having been valued as double the size of US real estate, it is an important sector for the Chinese economy, with roughly 30% of GDP attributable to it (including indirect effects). As a result of regulation to address issues of competition, data protection and better worker conditions that has clipped the wings of burgeoning technology companies, Chinese equities have fallen 15%. The capacity for swift anti-capitalist policy action in China, has shattered investor sentiment towards the region.
We reduced equity exposure to a more neutral position towards the end of last quarter and began building a Macro Strategy position to add resilience to portfolios. We expected a period of consolidation and we extend this view into the fourth quarter. We have been underweight fixed income and maintain this position as inflation and central bank policy present significant risks to this asset class. While there are mounting supply-side issues, we are entering a period of structural change as we exit the post-pandemic era and economic growth momentum remains positive. High asset prices have built up a potential for lower future returns, but we believe we are well positioned to weather emerging risks and are reassured by the ongoing transformational power of innovation and technology.