Market Update from Tatton Investment Management
November coming to an end offered plenty to be thankful – and fearful – about and once again market confidence is being controlled by COVID. In Europe, the case surge was surpassed by fears of a new “variant of significant concern” emanating from South Africa.
Over the weekend, new travel restrictions and tougher quarantine measures were imposed as countries across the world acted to delay the risk of transmission. New variants are always a risk, but each of the past ones has been dealt with by the vaccines. Still, we cannot be complacent, and the next few weeks will be subject to uncertainty as the world waits for more information.
US markets hit new highs just before Thanksgiving, but the mood darkened as details of the ‘Omicron’ variant unfolded, and investors sold out of pandemic-exposed sectors – travel and leisure were especially hard hit. Almost all market moves seemed in line with an anticipation of a significant hit to global growth. Government bond values rose, although corporate bonds were less in favour because of credit risk concerns; oil, metal and equity markets retrenched.
Despite the arrival of Omicron, there’s good reason to think that the global economy is on a bit of a roll. In the US, the weekly data on unemployment showed the lowest number of initial claims in a single week since 1968. Employment globally is strong, corporate confidence about sales is very positive, while there are signs that supply chain issues are easing up. There may not be enough truck drivers, but the container ships are moving more easily.
However, how central banks deal with inflationary pressures is key. the minutes from the last US Federal Reserve (Fed) meeting gave markets further reason to expect it will attempt to exert a firmer grip on monetary policy going forward. Meanwhile, the European Central Bank (ECB) has followed the Fed’s earlier policy by indicating a change to its fiscal support of buying bonds in the future, but not for now. the ECB has a definitive policy to pandemic support: the Pandemic Emergency Purchase Programme (PEPP) which is widely expected to be wound down. However, the Asset Purchase Programme (APP) already in place before the pandemic is expected to be increased to €40 billion, to ensure that the tapering is smoother.
Even a slight flex of the major central banks’ hand may spook markets. Perhaps we are already seeing that in the prices of the more speculative assets. Aside from the US mega-caps, equity prices have mostly been marking time. And, after the third quarter earnings season, US equity analysts have become less positive, with downgrades outnumbering upgrades for the first time since the start of the pandemic recovery rally. It is possible, the slow-moving central bank policy changes may coincide with faster-moving virus news, leading to increased volatility.
We believe the cycle will continue, but that market volatility could continue in the short term. Aside from Covid there are some other notable potential short-term risks. Further increases in energy prices, which markets could impact as a serious dent on households’ real disposable incomes, as well as profit margins of energy providers. On an international scale, the most obvious risk is China mismanaging its property crisis, and hence not only leading to lower growth in China, but also exporting tighter financing conditions to the rest of the world.
Overall, the recovery is set, but behind the recent Covid setbacks, the action of the central banks and when and if they act on inflation and end their pandemic fiscal support is key indicator to follow.
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