October Monthly Note
UK economic growth hit 5.5% between April and June, new data shows, after being revised up from the previous estimation of 4.8% according to the ONS. GDP now remains just 3.3% lower than before the pandemic at the end of 2019. September also brought us to the end of the widely successful furlough scheme introduced to protect jobs during the pandemic-induced lockdowns. What remains to be seen now is the impact this has on unemployment with many economists predicting those staff still on furlough are likely to be let go.
The biggest talk in the European Union currently is the German election which is in progress. Germany’s four biggest parties have held a series of bilateral meetings to further examine their positions before deciding on next steps in forming a government, Germany’s first without Angela Merkel for 16 years! Meanwhile the European Central Bank (ECB) has decided to slow the pace of asset purchases, with President Christine Lagarde careful not to call this tapering but a “recalibration” amid the stronger near-term outlook for prices and growth.
The US has begun its regular debt ceiling debacle, whereby lawmakers negotiate intensely for several weeks before eventually (always) agreeing to raise the debt ceiling, which is the amount of money the US is legally allowed to borrow. Treasury Secretary Janet Yellen renewed her call to Congress to raise or suspend the debt ceiling, saying that the government would otherwise run out of money in October.
The hugely indebted Chinese property giant Evergrande has sent ripples through global markets in September as it became apparent it would not be able to meet its debt financing obligations. The company has now missed interest payments to foreign investors totalling tens of millions of dollars. The government in China has since stepped in to guarantee part of the debt owed to domestic holders, which seemed to calm markets that feared this would be China’s Lehman moment, in comparison with the collapse of the US investment bank Lehman Brother’s during the Global Financial Crisis., which caused widespread global contagion and hit markets everywhere.
The macro backdrop remains supportive for risk assets, such as equities, which will benefit from further expanding global economic growth. Some value equities offer more immediate upside over their growth peers, as they tend to benefit most from strong recoveries after recession. We are taking a more cautious approach to portfolio positioning for a possible resurgence in inflation. We still like selective growth stocks where there remains true innovation and potential for change, especially recent trends in consumer behaviour being driven by the pandemic. Fixed income remains unattractive given record low (and negative) real yields and the thin spread between sovereigns and corporates offering little in the way of reward for risk. Bonds remain an important diversifier in our portfolios, but given current yields the return profile looks unappealing, with downside risk in long-dated government bonds extremely elevated given the outlook for interest rates and recent commentary from major investment banks regarding monetary tightening. Low duration bonds therefore look the more appealing investment, along with inflation-linked bonds which offer some protection to rising inflation.
We expect the UK to continue to recover well from the pandemic as the widely successful vaccine rollout and ending of pandemic restrictions in England boosts economic activity. The UK has some of the highest forecasted GDP growth in the world which should feed through to corporate profits which we expect to rise.
There is good value to be found in European equities, particularly given the recent pick-up in the EU’s vaccine programme, however Europe remains behind others in reopening the economy, thus we expect European equities to remain volatile, with the potential for strong earnings growth once restrictions are eased.
The US represents poorer value relative to the rest of the world due to the high proportion of tech companies that currently command a multiple far in excess of the broader market, however it also has the best long-term earnings growth and some of the most outstanding quality companies, as well as the most innovative. We believe the US will remain an attractive investment option, but with some obvious headwinds making us more cautious. President Biden has made no secret of his desire to increase tax rates, and the Federal Reserve have been clear they will not be getting any more accommodative.
We believe Japan to be an extremely poor environment for equity performance. The Japanese economy is predicted to grow at the slowest pace of all regions, in addition with a declining and ageing population, the prospect of future economic expansion looks unlikely. Thus, we expect poor equity performance from Japan. Asia Pacific and Emerging Markets are predicted to see exceptionally strong GDP growth over the next year, but are struggling with the pandemic, particularly those countries who are not so able to distribute vaccinations to their populations. We remain concerned at the decreasing Chinese stimulus, together with regulatory crackdowns, investments in China require careful monitoring. As China is the largest economy in this region, such events have regional ramifications. Emerging Market stocks are also unlikely to perform well in an inflationary environment given that many corporates tend to be highly geared and are highly sensitive to rises in interest rates.
The opinions expressed in this update are those of A&J Wealth Management Limited only, as at 4th October 2021, and are subject to change.
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