3Q 2021 | Guide to the Markets
Inflation concerns are likely to generate volatility
In the developed world, the easing of virus-related restrictions is resulting in a surge in demand. Supply is struggling to keep pace and the result has been meaningful upside inflation surprises in many regions (Guide to the Markets – Europe pg 6). As the market looks to the second half of the year, it is questioning whether the surge in growth and inflation will prove transitory (pg 7). We believe growth will remain strong as considerable pent-up savings are still to be unleashed (pg 10). However, we also expect inflationary concerns to linger. Questions over what this all means for monetary policy may generate volatility. Our core expectation is that monetary policy will be tightened only gradually (pg 9). Gradual rate increases will raise longer-term bond yields but shouldn’t hinder the economic expansion.
Stick with rotation to value
The strong growth and modest inflation backdrop is expected to support corporate earnings (pg 51). While valuations in some segments of the market may suggest this strong outlook is already priced in, that is not true of all areas. Despite the strong outperformance in the first half of the year we still see the most attractive opportunities in the value segments of the market, such as financials (pg 46). Rising bond yields would certainly help this style rotation, as well as a regional shift in relative performance (pg 63).
Consider portfolio implications of COP26
Leaders of over 190 nations are hoping to gather in Scotland in early November for the 26th Conference of Parties (COP26). President Biden has brought the US back to the table and increased the global momentum towards tackling climate change. The group will aim to flesh out a coherent plan to reach zero emissions in the coming decades (pg 78). Infrastructure overhaul is one part of the conversation. A common carbon price is a critical but contentious part of the discussions (pg 79). Investors should be increasingly aware of the implications for the assets in their portfolio, beyond the most obvious sectors such as energy (pg 81).
Seek protection from choppy waters
While the risks of a virus mutation remain, the news so far on vaccine efficacy with new mutations is encouraging. The key risk in our view, therefore, is that inflation is persistently troublesome. For investors, this means that bonds – which are supposed to be a key source of portfolio ballast – are actually a key risk. We believe investors should think about the opportunities in Chinese bonds (pg 70), as well as alternatives, such as macro funds and core infrastructure (pgs 74 & 75).