The economic restart is well under way, with buoyant economic data emerging from most major economies. However, the world can only reopen once and we are entering the ‘post-restart’ era, with potentially slower growth. What do investors need to look out for in this new environment?
Inflation running hot
It’s the obvious choice, but it does matter. In fact, it’s the biggest question facing investors today. Will inflation prove to be ‘transitory’, as central banks currently predict, or will it run hotter than expected?
The ‘it’s nothing to worry about’ side point to the ongoing deflationary forces in the economy such as demographics and technology. The opposing side points to companies increasingly reporting higher input costs, or, even, boasting about their ability to put up prices. With a nine-month lead time on semiconductors, there are still supply chain shortages of key elements.
Much will hinge on what happens in the labour market. As it stands, certain sectors are struggling to tempt people away from their Covid support payments and back into the workforce. Wages are rising as a result, while job vacancies continue to climb. Few are inclined to predict what will happen as employment support schemes are phased out.
The question is whether central banks will be forced to act. While most have said they will ‘look through’ higher inflation, they have started to hint at action. If there is the smallest hint that rates will rise, it will create a sudden shock for asset markets.
The direction of bond yields
There is a potential scenario where inflation rises, but bond yields stay low. Central banks decide inflation is temporary and keep interest rates near zero, yet inflation continues to exert a force on asset markets.
This could make for a strange mix. Bond yields may remain low, thereby continuing to act as a diversifier in a portfolio. At the same time, growth stocks could continue to do well. The high valuations of growth stocks started to look elevated as the prospect of higher interest rates loomed. However, if interest rates are to remain low, these valuations could be justified. Rather than value or growth, it could be value and growth.
There are some unusual forces operating in bond markets at the moment. Central bank buying continues to distort yields. However, investors shouldn’t necessarily assume that lower yields are a mistake. Perhaps the bond market is still trying to tell investors something. It is worth keeping a close eye on bond yields.
China and geopolitics
Much though Western powers might wish it otherwise, China matters to the world economy and to financial markets. Its economic strength through 2020 provided a much-needed support to the global economy.
However, the Chinese markets have sold off significantly in recent weeks. While its economy continues to thrive, government interference in the technology sector has created jitters. This has had repercussions across financial markets. It is a reminder that Chinese companies are subject to myriad complex forces.
It is also worth noting that China is becoming increasingly assertive on the global stage. Its incursions into Taiwan and Hong Kong clearly show its geopolitical ambitions and direction of travel. This could be important if Western powers feel the need to act in the face of Chinese provocation.
Post-pandemic change: real or illusory
There has been considerable discussion about the changes wrought by Covid: from agile working, to digitisation, to online retail. However, the persistence of these trends is still open to question. For example, will companies really embrace agile working? Or will employees develop FOMO when they see colleagues returning to the office? The assumption is that a hybrid will emerge, but it is not assured.
It is a similar picture with online retail, or digitisation. Significant assumptions have been made about the key trends accelerated by the pandemic, but the next few months will test whether life is really different post-pandemic, or whether weary consumers and workers will simply revert to their old patterns. Change generally takes longer than people think. Investors need to watch closely to see if the lofty growth projections for many of these new areas come to pass.
The reality of ESG
2020 saw ‘green’ stocks fly. Share price for companies involved in the transition to renewable energy moved significantly higher as the UK, US and Europe announced vast spending packages to hit net zero targets. However, 2021 is when that money will start to be spent in earnest. Which companies will really benefit? Will it be distributed as expected?
It is also a time when investors are becoming more discerning and sophisticated on ESG. Many have started to question the analysis of the rating agencies and are more adept at spotting greenwashing by a good investor relations department. This may start to be felt in share prices.