Robust corporate earnings and abundant liquidity enabled global equity markets to make further gains in August and establish all-time highs towards the end of the month. Although economic growth remains strong in absolute terms, at the margin actual numbers and survey data have surprised on the downside. This reflected a further deceleration in China and sharply rising COVID cases - particularly in the US and Asia. Central banks remain cautious about withdrawing support with the Federal Reserve’s Economic Symposium at Jackson Hole providing no clues on the timing of asset purchase tapering. Pandemic-related supply chain disruption continues to distort inflation and may also be affecting consumer spending
Most major markets returned between 3% and 4% while conventional bonds produced small loses as yields rose. The US recorded a seventh consecutive monthly gain with technology once again a significant contributor. Japanese equities broke out of their recent trading range and Asian and emerging markets also made useful gains. China ended flat having trended down since mid-February on a number of factors including recent regulatory changes. Europe and the UK lagged but still gained around 2.5%. Sterling weakness against most major currencies boosted returns for UK based investors with cable closing at $1.37. After a volatile month, Brent crude ended marginally down at $73. Following their downward trend over the last four months, bond yields picked up with US Treasuries closing at 1.3%, Bunds at -0.38% and gilts at 0.6%. A rise in breakeven rates helped UK index-linked gilts produce a small positive return.
The rise in COVID infections across Asia is impacting growth in China. Despite the official manufacturing business survey suggesting that larger state-owned enterprises are still expanding, surveys of smaller, mainly privately owned manufacturing companies indicate a contraction over the coming months. The August services’ survey fell sharply into contraction territory and exports, domestic retail sales and consumer confidence have also declined. The latter may reflect moderating house prices, virus-related anxiety driven by the zero tolerance approach to new outbreaks and recent “common prosperity” policy initiatives. Longer-term investment opportunities remain but there is likely to be less emphasis on conspicuous consumption of luxury goods.
August’s ISM Manufacturing survey
Although August’s ISM Manufacturing survey was stronger than expected, we suspect US growth has also decelerated as a result of the widespread rise in COVID infections. News on the consumer front is more mixed: while restaurant spending is back to pre-COVID levels and year-on-year mobility data has increased, air travel has dipped again and, as with cinema attendance, which remain below pre-pandemic levels. Anxiety over public health continues with the number of employees returning to work still 70% below February 2020 and the latest University of Michigan survey reporting a downturn in consumer confidence. This is particularly evident in Republican states which are experiencing high Delta variant infections. Weekly and continuing jobless claims continue to fall but vacancies were at a record 10m at the end of June and 12m were still receiving some form of benefit in mid-August. The picture should improve in September and any plateau in demand could reduce supply chain pressures and allow some inventory re-stocking.
Eurozone business surveys surprised on the downside in August albeit from near record levels. Supply chain disruption and price pressures were widely cited with German manufacturing hit especially hard. Services, however, have held up and overtook manufacturing for the first time since spring 2020. The overall composite is consistent with relatively strong GDP growth in Q3. Although July’s 2.2% inflation figure was higher than expected predominately due to a 14% year-on-year rise in energy prices, the core measure preferred by the European Central Bank - which excludes food and energy - rose only 0.9%. Bond yields spiked up following surprisingly hawkish comments from the ECB President and other policymakers. Attention is now turning to the German elections on 26 September and the prospect of a “Jamaica coalition” with Olaf Scholz as the next Chancellor.
UK manufacturing appears to be holding steady but there was a sharp downturn in services in August. Despite some easing of price pressures, supply chain shortages are a constraint for manufacturers while the weak services’ data appears to reflect a dip in consumer spending that cannot be attributed solely to the “pingdemic”. While new orders and employment remain above the boom/bust divide of 50, economic activity appears to be losing momentum. Employment news was more encouraging with the rate back to 0.75% - 1.5% below the pre-pandemic level. Headline average earnings growth has spiked higher but, allowing for base and compositional effects including furlough, is probably running at around 3.5% per annum or broadly in line with the pre-pandemic rate. Job vacancies in July reached an all-time high of just under 1m and, even though unemployment remains low, the post-Brexit skills mismatch suggests it will rise when furlough ends.
As autumn approaches, attention will turn to the outlook for 2022 and the durability of the recovery once central banks start to unwind support measures. Global GDP is expected to increase by just under 6% this year and 4.3% in 2022 with the latter estimate seeing modest upward revisions. Although the assumption is that the world will learn to live with the pandemic, it is worth bearing in mind the significant numbers who have not yet been vaccinated. After two exceptional years, global earnings growth is projected to normalise at around 8% in 2022. Regional variations are lower than those experienced recently mainly because technology is pencilled in for more normal - but still above average - 11% growth. There is a strong cyclical element to current forecasts with higher growth from industrials and consumer discretionary. Energy could be an interesting sector as the prospect of above average growth and, by historical standards, cheap valuations is challenged by the increasing focus on sustainability. While we are reasonably relaxed about the outlook for markets - even with modestly higher bond yields - we would be more enthusiastic were it not for high valuations which are likely to limit progress.