More than a year on from the start of the pandemic, the economic recovery is now well and truly underway. Growth forecasts are strong and continue to be revised higher. Purchasing Managers’ Index (PMI) surveys, a gauge of economic activity, have registered strong gains in 2021 for the US, UK and Eurozone. In the UK, the Services PMI has enjoyed a notable boost in recent months as Covid-related restrictions were eased, and retail and hospitality venues reopened. Importantly, savings rates remain comparatively high in both the US and UK, suggesting significant levels of pent-up consumer demand. Reflecting the broad optimism on economic strength, forecasts for S&P earnings remain upbeat and earnings recovery is expected to continue into 2022, following significant positive earnings per share ‘beats’ in recent quarters.
Vaccines come to the rescue…for some
Clearly, the rapid development and rollout of Covid-19 vaccines has been critical to the economic recovery. Developed market countries are performing well, notably the US and UK, with the latter having fully vaccinated over 50% of its adult population. Previous vaccine rollout laggards Canada and the EU have stepped up their efforts and are gradually catching up; however, a lack of vaccine availability has meant that many emerging market countries are now far behind. Despite the progress made, new variants of the virus, which have the potential to reduce the efficacy or even evade vaccines, remain a threat to the relaxing of restrictions and the continuation of the economic recovery.
Easy financial conditions are here to stay…
The levels of government stimulus and the support from central banks in response to the pandemic remains unprecedented. For example, in the US, Covid-related relief and stimulus bills totalling at least $5 trillion have been signed into law. Not only have central banks cut rates to near zero levels, but they have also implemented vast asset purchase programmes in terms of both scale and breadth: the US Federal Reserve extended their asset purchase programme to include both high yield ETFs and so called ‘fallen angels’ (BB-rated corporate bonds) in mid-2020. The stimulus is likely to have long-lasting effects, and we expect that real yields will remain low – indeed negative – for some time to come. Despite the positive economic momentum that we have seen in recent months, central banks generally see rates on hold for several more years, suggesting easy financial conditions are here to stay for the foreseeable future.
…But inflation is a key concern
A short-term surge in US inflation indicators is leading to worries of longer-lasting pressures. Whilst financial conditions have been highly supportive, nominal bond yields have risen, primarily reflecting increases in breakeven inflation. The upcoming surge in demand brought on by a relaxation of restrictions and drawdown of significant consumer savings is leading to a stronger economic growth backdrop. This, coupled with base effects from the low readings of 2020, suggest that inflation worries look set to increase in the near term. In addition, commodity prices have also surged, with the key industrial metal, copper, reaching a new high in May 2021. While short-term bottlenecks in production are also currently playing a role, there is much debate among market participants over the nature of the higher inflation that we are currently seeing – in terms of whether it is transitory or more sustained. While we by no means expect a return to the level of inflation seen in the 1970s, a tilt to slightly higher inflation in the shorter term seems likely.
The outlook remains uncertain
With so many competing factors the outlook, as always, remains uncertain. Nonetheless, a brisk economic recovery along with supportive policy and low interest rates is positive for equity markets. Higher inflation is a risk for investors but, in our view, it is unlikely to materially undermine the attraction of equity markets. Stronger growth and a gentle uptick in inflation, combined with current valuations within equity markets, has led to a broadening in performance within equities, beyond the narrow set of disruptive leaders and ‘lockdown winners’.
Our approach of diversifying the F&C Investment Trust portfolio across a range of geographies, sectors and investment styles, and accessing selective opportunities in private markets space has, over many decades, provided shareholders with consistent long-term returns. Whilst it is likely that markets will continue to face economic and Covid-related aftershocks in 2021, we remain focused on long-term opportunities across both listed and private equity markets for the benefit of our shareholders.