COVID-19 has been a central theme to this column for the past year or so. It has dominated headlines as the pandemic and resulting lockdown saw a significant fall for risk assets, followed by a steady recovery supported by unprecedented fiscal support from governments and central banks around the globe.
With vaccination efforts now well advanced in most developed economies, and COVID-19 numbers generally lower as a result, eyes have turned to the next stage of the economic recovery as lockdown measures are eased.
This gradual opening up has helped those sectors which had been hit hardest by the lockdown – such as hospitality and retail – recover as customers are now able to return. This is offering potential value to would-be investors, and has also helped a number of indices reach, or approach, historic highs during the last quarter.
We have also seen positive economic figures released. The US economy grew by 6.4% in Q1 and is forecast to grow 6.6% in 2021. In the UK, the Bank of England raised its estimate for UK GDP growth to 7.25% in 2021 – compared to a forecast of 5% made in February. Although the EU’s figures are a little lower – a predicted 4.2% GDP growth in 2021 followed by 4.4% in 2022 – these forecasts from May still represented a significant upgrade on earlier ones.
From an investment point of view, these figures should offer confidence, though it must be remembered that this growth is largely just making up from the slowdown we saw during the pandemic.
It has also caused the spectre of inflation to once again rear its head. In my last Quarterly Market Update, I mentioned that many were expecting inflation to increase. These expectations have now become a reality, with US inflation breaking 5% in May, and UK and eurozone inflation also substantially up.
With higher inflation on the cards, questions are now being asked about how central banks intend to respond. In general, the fiscal taps remain open for now, while interest rates are yet to rise. However, if the recovery gains traction and inflation remains elevated, it seems likely that rate rises and tapering of support measures may occur sooner than later.
The inflation story is rapidly developing, as markets attempt to fully understand the nature of the inflation (whether it is transitory, or if we are in for a longer period of higher inflation). Bringing forward the projected interest rate rise in the US saw markets become temporarily quite volatile, at least until officials were able to assure investors that any action taken will be gradual and signposted in advance.
The good news is that, as we have known about this risk for some time, we have been able to prepare for it. Our model Portfolios, for example, are currently weighted towards high-yield debt as opposed to government bonds, given the latter can struggle in a higher inflationary environment. It is also worth noting that our Portfolio stress tests include testing their ability to withstand rising inflation, among other risks, as we seek to protect against multiple potential futures.
While in theory rising inflation should have seen a continued rotation away from the sort of growth shares which benefited from lockdown towards value options which will benefit from economies opening, the reality has been a little more complicated than that. The past three months have seen plenty of opportunities for investors looking to rotate their options , and as a result indices such as the FTSE 100 have performed well. At the same time, however, there have been a number of technology companies performing well, with tech-heavy indices such as the Nasdaq hitting record highs.
While inflation and COVID-19 have dominated headlines for much of the past three months, the G7 meeting held in June included discussions which, if they ever result in action, could have far-reaching implications. Notably, the international attendees agreed to the principle of a global minimum corporate tax rate of 15%. For multinationals based in low-taxation regions, this could add additional tax burdens to their bottom line. That said, there is a long way to go before such an ambition becomes reality, including getting countries that rely on favourable tax regimes to attract businesses on board; and markets have remained relatively calm about the announcement.
This has all made for an interesting quarter. While the threat of COVID-19 has not totally disappeared, it appears to be retreating for now, and the gradual easing of lockdown measures in many countries has opened up new opportunities for investors . Growing inflationary trends and the possible rise of interest rates are complicating matters. However, with a well-diversified portfolio and considered financial plan, investors should be confident about the long-term prospects for returns from real assets.
The information contained is correct as at the date of the article. The information contained does not constitute investment advice and is not intended to state, indicate or imply that current or past results are indicative of future results or expectations.