Despite fears that August would subject investors to an upset, with many predicting that thin market liquidity during the peak holiday season presented a considerable risk, equity markets have continued to make progress, building on already decent gains made earlier in the year. Indeed, global indices, notably the MSCI All-Countries World Index, made no fewer than seven new all-time highs during the month (punctuated by a short-lived 2% setback in the middle). Bond markets were also much calmer than they had been for a while, with both sovereign and corporate yields remaining in relatively narrow ranges. An observer from Mars might well conclude from this that all is well on planet Earth, but a closer inspection of the headlines reveals plenty of things to worry about, and the autumn appears to offer the prospect for ongoing heated debate about the sustainability of returns.
As has been the case for some time, the key drivers to sentiment remain COVID developments and the outlook for monetary policy. The former continues to have a considerable bearing on economic activity and short-term inflation outcomes, although the consensus opinion is that vaccination programmes will eventually allow life to return to something close to normal. Meanwhile central banks are sowing the seeds for the next policy tightening cycle, although are generally reluctant to apply much fertiliser yet.
The headlines over the summer have been dominated by events in Afghanistan, with the United States and its allies announcing the withdrawal of troops from the country. This has led to the Taliban effectively taking control, negating almost two decades of attempts to establish a regime more friendly to Western interests. However, it is fair to say that these events and their undoubtedly tragic consequences for many have had a minimal impact on financial markets.
Returning to COVID, the main development in recent months has been the increased prevalence of the Delta variant, which is proving to be, if not the most virulent, then certainly the most transmissible variant so far. Even countries with high vaccination rates have struggled (and generally failed) to contain its spread, although, thankfully, the vaccines have reduced the incidence of hospitalisations and fatalities. It is notable that countries such as Germany and Vietnam, both of which fared relatively well in the early waves of COVID, have been much more badly affected this time. Both countries feature heavily in global manufacturing supply chains, and it is here that the economic effects of the virus have been most impactful, with many companies reporting shortages of materials and products.
In the UK, specifically, a lack of Heavy Goods Vehicle drivers is widely cited as a major constraint. All of this is leading to price rises for a number of goods, which is reflected in rising inflation readings almost everywhere.
What the latest disruption has achieved is to halt the steady rise we had been seeing in economic growth forecasts. Indeed, we have seen some downgrading of growth expectations on both sides of the Atlantic in recent weeks. Corporate earnings forecasts have been more robust so far, supported by what was an exceptionally strong second quarter earnings season.
Last in this section, but by no means least, climate change remains an important topic for investors. This was underlined by the latest report from the United Nations’ Intergovernmental Panel on Climate Change (IPCC). Its tone was distinctly gloomier than previously, conveying a need for stronger and more immediate action. It certainly set the stage for the forthcoming COP26 gathering in Glasgow. We continue to take the threat of climate change extremely seriously in our analysis as part of our initiative to integrate even more fully environmental, social and governance (ESG) factors into the investment process. This extends from asset allocation to the evaluation of individual stocks.
It is impossible to overemphasise the challenges that lie ahead. While it is widely recognised that behavioural change is necessary and inevitable, this will, in all probability, only be achieved by policy-led enforcement and economic incentives (a yet-to-be-determined mix of carrot and stick). There are likely to be nasty surprises as well as attractive new opportunities for investment.
As we move into the final third of the year, our message remains very much as it has been so far this year: while it is hard to argue that equities or bonds are particularly cheap, there is no compelling reason to head for the exit either. We are on a recovery path which we always suspected would be bumpy and there have certainly been some testing moments. But staying fully invested has been rewarding.
We have commented on several occasions in the past that the greatest dangers to investment portfolios arise during periods of increasingly restrictive liquidity conditions and rapidly falling growth expectations. While we have certainly passed the points of both peak liquidity provision (in terms of central bank balance sheet expansion) and peak recovery (in terms of year-on-year growth in economic output and corporate profits), the fact that both are still positive suggests a period of less generous portfolio returns rather than a severe setback.
If you have any questions regarding this update or your own financial planning needs, please do not hesitate to get in touch on 0117 450 1300.