September was a bad month for investors. Losses on bonds and losses on equities. Signs of slowing growth momentum combined with high inflation. Here in the UK, pictures of desperate motorists queuing for petrol look like scenes for a developing economy. It all looks dreadful; but there are reasons to be optimistic…
Regular readers will recall that I went negative on equities four weeks ago looking for a 5-10% correction but said that that would be a buying opportunity. In terms of the S&P 500, we sneaked into that range on Thursday, down 5.3% from the high in early September. I always prefer to buy a market when sentiment is negative but news flow is positive. I can see good news ahead for equities and, to my mind, they are much more attractive now than they were a month ago.
To explain, let’s begin with the virus
The latest data shows new cases falling in almost every country. We already knew that vaccination weakens the link between getting the disease and requiring hospitalisation. The recent data for Merck that their new drug reduces that by a further half is excellent news. Yes, the results have not been peer reviewed and the sample was small, but the signs are good that other antiviral drugs currently being tested will also be highly effective. The new normal involves living with Covid and the news from Merck suggests that that life could be better than previously thought.
Shortages in abundance, but very supportive financial conditions
Economic data shows shortages throughout the economy, throughout the world of labour, of semi-conductors, of energy. The pandemic recession was severe and sharp, the recovery has been rapid. Dislocations and shortages are hardly surprising.
I have great faith in the private sector’s ability to respond to these challenges. Later this month, the corporate reporting season gets going in the US and it is likely to be positive, led by banks. They will be writing back loan loss provisions that were made last year but don’t need to be utilised. Indeed, banks are generally in remarkably good health, in sharp contrast to the situation after the Global Financial Crisis. Financial conditions generally are very supportive in developed markets.
Surge in capex should lead to higher productivity; a major positive for risk assets
One consequence of a healthy financial background and strong corporate profitability is a boom in capital expenditure. In most developed economies, this has floundered since the dot-com bubble burst 20 years ago, ending what had been a secular upward trend. Recent data shows a surge, breaking out of the range. Higher productivity should follow, allowing firms to raise wages and maintain profit growth. It’s a major positive for risk assets.
Inflation has the potential to halt the rally, but I remain optimistic
Of course, if inflation were to take off, forcing central banks to slam on the brakes, those gains would be lost. I do expect central banks to raise interest rates. After all, they were cut in response to an emergency that is now over.
That is undeniably a headwind, but I think the economic recovery has further to go as supply shortages ease, so that headwind will merely slow, rather than halt, the rally in equities.
Past performance is not a guide to future performance. The value of investments and any income derived from them can go down as well as up and investors may not get back the original amount invested.
The information, opinions, estimates or forecasts contained in this document were obtained from sources reasonably believed to be reliable and are subject to change at any time.
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