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Monthly Market Commentary - November 2021

Date: 12 November 2021

Strong corporate results helped global equity markets achieve new all-time highs in October, despite the prospect of slower economic growth and concerns about supply chain disruptions and higher inflation. Although bond market volatility continued, as short-dated yields rose in anticipation of central banks raising interest rates earlier than expected, the decline in long-dated yields enabled the index to close in positive territory.

In local currency terms, US equities returned over 7% - significantly ahead of Europe (4%) and the UK (2%) - and clawed back some of the ground lost in September. Asian and emerging markets were flat and Japan was down. Yen weakness and a modest appreciation in sterling to $1.37 reduced international returns for sterling-based investors with a typical diversified balanced portfolio returning 2%. While gilts recovered slightly, they are still 5% below their high at the start of 2021. Brent crude closed up 7% at $84 - 20% above pre-pandemic levels - and gold rose marginally to $1,782.

Inflation continues to surprise

Inflation continues to surprise on the upside and is likely to remain high into next year. The Federal Reserve and European Central Bank are sticking to their view that price rises are predominately the result of supply chain disruptions and will, in time, revert to normal without any lasting pass through to goods or services. Both plan to taper asset purchases before raising interest rates although bond markets are discounting a different outcome. The Bank of England appears to be more hawkish with some observers predicting a 15bp rate rise before Christmas. The transitory nature of the inflation uptick is the subject of much debate and, while it seems logical for prices of most goods to revert once supplies resume, the pandemic has highlighted how the global supply chain may have become so finely optimised over the past decade that it is now vulnerable to major changes in demand. For example, the congestion at many ports may not simply reflect backlogs and inventory restocking but could imply a fundamental lack of the warehouse and distribution capacity needed to maximise production efficiency. If this results in more investment and diversification of suppliers, there are likely to be some cost increases but not a material uplift in inflation. The area of greatest uncertainty is jobs and wages, with evidence that the gradual return to work has not been at a sufficient pace to fill the large number of vacancies. The US still has more than 5 million fewer in employment, than prior to the pandemic, yet there are pockets of wage inflation especially in lower skilled, lower paid segments of the workforce.

While recent economic data has generally surprised on the downside, we think this is a mid-cycle transition and global GDP remains on track to grow 5.5% this year and over 4% in 2022 before gradually reverting to trend. China and the US continue to be the main contributors with both experiencing the negative impact of supply chain disruption and higher energy prices. Q3 GDP growth in China slowed to 4.9% compared to 18%+ in Q1. The authorities’ selective response to power shortages and the Evergrande debt crisis indicates a determination to curb real estate investment and has disappointed those who anticipated a broad-based stimulus package. Combined with the recent wave of regulatory action to support “common prosperity”, it suggests the policy is to move towards more sustainable growth and this may impact consumer confidence. US GDP slowed to 2% in Q3 - below estimates of 2.7% and significantly down on Q2’s 6.7%. Excluding inventories, core growth was flat, net exports weak and consumer spending rose only 1.6%. The latter mainly reflects limited automobile availability - production was 46% lower because of chip shortages - rather than a lack of jobs or high Covid-19 infection rates.

Japan and Europe are also experiencing supply chain headwinds. A sharp fall in Covid-19 infections and a rise in vaccinations allowed the state of emergency in Japan to be lifted and this should boost spending on hospitality, travel and leisure, albeit the Kishida administration’s supplementary budget is expected to focus more on income disparities than growth. With higher energy prices and yen depreciation, inflation has edged up, but as demand for goods during the pandemic has been steadier than elsewhere, it has been more difficult to pass on opportunistic price increases. Q3 GDP of around 2.4% in the Eurozone is likely to be little changed from Q2 before slowing in Q4 on supply chain bottlenecks. Covid-19 infections are declining and the increase in vaccinations is reducing hospitalisations. Negotiations continue on forming a coalition government in Germany and higher taxation appears unlikely despite pledges to reduce bureaucracy and increase investment. Of more significance to equity investors is the promise to raise the minimum hourly wage by 20% to 12 euros - possibly as early as 2022. Although surveys suggest sentiment is poor, the strong order backlog should be positive for growth. With EU fiscal rules suspended, tax revenues at pre-pandemic levels and grants from the EU Recovery and Resilience Fund starting to kick in, the background remains supportive.

Signs that UK growth is levelling off are not simply the result of supply chain disruption but also reflect rising Covid-19 infections, labour shortages and Brexit. The Office of Budget Responsibility now expects Brexit to cause more permanent damage to the economy than the pandemic. Extreme weakness in July means Q3 GDP could be as low as 1.5% before recovering to 4% next year. Forward-looking business surveys in October were more optimistic with both manufacturing and services surprising on the upside. A better-than-expected recovery and lower loan write-offs gave the Chancellor scope for fiscal easing equivalent to 1% of GDP over the next two years without derailing the plan to balance the budget by 2024. However, levelling up, investment in skills and other measures are unlikely to offset the hit to real disposable incomes from higher energy costs and the pre-announced changes to taxation and National Insurance.

Just over 50% of US companies have reported Q3 results with around 80% beating estimates. The first results - predominately from the financial sector - were very strong reflecting high levels of corporate listings and associated investment bank activity as well as lower loan provisions but, as the reporting season progressed, a broader spectrum of companies have emphasised cost pressures and supply chain constraints. Several of the largest technology companies missed expectations, albeit by a small margin, in the context of their recent growth. Companies posting disappointing results have seen their share prices suffer which is not surprising in view of high valuation levels. However, as investors look ahead to 2022, there is a cautionary note given slower GDP growth means that earnings are likely to revert to normal at a time when interest rates are expected to rise and central banks will be scaling back asset purchases. While equities should perform better than bonds, gains may be more modest.


Duncan Gwyther

Chief Investment Officer

Duncan is the Chief Investment Officer with overall responsibility for the firm’s investment strategy. He chairs the Investment Group and Asset Allocation Committee. He is also a lead investment manager for Quilter Cheviot’s institutional clients.

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