Global Markets to 5 March 2021
- Turmoil in the bond markets triggers a negative response from global investors.
- Nerves run high on the back of the threat of higher inflation and a possible central bank error.
- In the UK, Chancellor Sunak delivers his “spend now, tax later” budget.
- China unveils its next five-year plan.
- Exciting investment opportunities mean that global equity markets can weather bond market turmoil.
Global Market Summary
Investors have not responded well to the recent turmoil in the bond markets: the technology sector has been hit particularly hard by negative sentiment. The threat of rising inflation and the potential for a central bank policy error have spooked market sentiment.
History has shown that when bond yields and interest rates remain low for long periods of time, global equity market returns are generous. Over the past decade, accommodative central bank policy has created perfect conditions for growth stocks, although the economic backdrop has been badly affected by a number of financial catastrophes and the ongoing pandemic.
This time last year, the financial markets were about to be rocked by the start of a pandemic that would go on to paralyse the global economy. Governments and central banks then implemented the most significant set of support and stimulus packages ever announced to protect jobs and shore up the economy as coronavirus started to take its toll.
The result was a set of circumstances that saw bond prices rocket while yields were pushed downwards to historic lows – and even, in some cases, into negative territory. Twelve months and several successful vaccines later, the world’s largest immunisation rollout has improved prospects considerably and the global economy is now expected to recover well.
Talk among the bond vigilantes about the prospect of higher inflation and a possible central bank policy error have pushed bond yields higher while prices have fallen. This has spooked the equity markets and triggered a measure of rotation out of last year’s winners (such as the technology sector) in favour of the more cyclical ones that might fare better in a higher-interest rate, more inflationary environment.
As far as the bond markets are concerned, these are likely to become volatile over the coming months. Indeed, as Warren Buffett recently warned shareholders in his Berkshire Hathaway statement, “bonds are not the place to be these days”. Needless to say, as vaccination campaigns are rolled out and the global economy gradually opens up, we can expect a broadening out in activity. This will be good for employment and will improve corporate profitability.
An improvement in the macro backdrop will leave bond investors with very little room for manoeuvre, although it will upgrade expectations for growth and increase the likelihood of inflation picking up, creating a short-term problem for the bond markets.
Federal Reserve Bank Chairman Jerome Powell also spooked the markets by suggesting that higher inflation would become more likely as the economy recovered, although he did add that he thought it would be temporary.
So without the prospect of more long-term inflation and while an immediate return to full employment seems highly improbable, the central bank is very unlikely to raise rates. It should also be remembered that the Fed is buying US$120 billion a month in Treasury and mortgage-backed securities. There have also been recent rumours on Wall Street that the central bank is considering implementing a new version of “Operation Twist” – the monetary policy initiative used in the past that involved it selling short-term notes and buying longer-dated bonds.
However, the risk is that doing so would be seen as influencing the long end of the bond market. The central bank does not expect any inflation or the recent rise in bond yields to last for very long. It is therefore more likely that it will continue with a more accommodative policy.
In the UK, Chancellor Rishi Sunak delivered his 2021 Budget following one of the largest and most sustained economic shocks the UK has ever suffered. The pandemic has pushed borrowing up to record levels: for the first time in sixty years, UK public debt is thought to be more than 100% of the country’s annual economic output to GDP ratio.
The Chancellor stressed that this debt must be reined in. While vaccines and the successful immunisation programme will hopefully create a strong economic rebound, tax increases would need to play a part in this overall debt reduction strategy. Personal taxation, however, has remained largely unchanged – at least for now. This means that the Conservatives have managed to honour their manifesto pledge not to raise taxes. But the Chancellor’s statement effectively allows for higher taxation on the back of rising wages and investment returns.
This year’s budget contained two key components: the package for further stimulus, and support for households and businesses, tilted to help certain sectors which have been hit the hardest during the pandemic. Under his “strengthening the public finances” heading, he announced a two-pronged tax policy. All the budget’s important details and its key takeaways are in our 2021 Budget Guide.
Last week saw the opening of the National People’s Congress in China. Attended by nearly 3000 delegates representing provinces, autonomous regions and the special administrative regions of Hong Kong and Macau, global authorities and the investment world pay very close attention to what is debated in this forum in the areas of human rights, poverty and China’s economic growth targets.
On Friday, Premier Li Keqiang addressed the NPC and warned the world not to interfere in Hong Kong’s governance or its future. He also said that the country had set its economic growth target at above 6%, before going on to update the NPC on its climate control objectives.
Over the next five days, the Congress will ratify the 14th five-year plan outlining the economic strategy for China. President Xi Jinping is also likely to comment on what the country has achieved so far on its war on poverty.
Last year was very much about the digital winners in a Covid-19 world versus those businesses which had been crushed by the pandemic and the lockdowns. This year is likely to see a very strong economic recovery as the world reopens and many of the sectors which have fared less well start to recover.
Debate about the finer details of this recovery will continue over the months ahead as vaccination programmes are rolled out all over the world. Talk of increases in inflation and the Fed’s initial decision to “do nothing and let the economy run hot for a while” have spooked the bond markets. This has led to the share prices of some of last year’s winners falling sharply in recent weeks.
While rotational swings within sectors and asset classes are likely to continue over the short term, we do not yet know how this will develop over the longer term. However, a widening out of investment opportunities looks certain: vaccination programmes and central bank support will continue to create a positive backdrop for a strong global economic recovery.
Although the bond markets will ultimately suffer when interest rates and inflation start to rise, innovation and the green revolution should still provide global investors with adequate opportunities – even if the returns are somewhat more moderate than in recent years.
Peter Lowman is the Chief Investment Officer at Investment Quorum, a Director of the company and an integral member of our investment committee.
This article does not constitute specific advice and investors should bear in mind that capital invested is not guaranteed. Investment Quorum is authorised and regulated by the Financial Conduct Authority.
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