It’s been a jittery week for equities with most markets lower; we are less concerned. In this week’s update, we’ll also explain why a shortage of milk on supermarket shelves in the UK suggests the Bank of England might raise interest rates sooner than expected.
There’s no doubt that the global rise in new cases as the Delta variant sweeps across the globe has rattled the markets. There’s also been a slew of weaker-than-expected economic data. Retail sales fell in July in the UK, US and China, and the latest PMIs have fallen almost everywhere. We are worried about developments in China, where economic weakness is combining with a political crackdown that began with what seemed like an isolated case of a single tech company but has now extended to a more generalised attack on the ultra-rich running big Chinese private companies, which could threaten to squeeze profit margins.
Vaccination programmes are a key determinant of economic recovery
For us, it makes sense to divide the world into those that have a strong vaccination programme and those that don’t. That favours developed markets over emerging markets, though there are exceptions like Australia and New Zealand who presumably cannot keep imposing stringent lockdowns and would struggle to persuade their populations to get vaccinated even if they had sufficient supply.
Jabs for jobs
The UK and the US are both exhibiting a surge in reported Covid cases. In the case of the US, this has led to a redoubling of efforts to persuade more people to get vaccinated. More and more employers are insisting on jabs for jobs, New York City is requiring vaccination evidence to get into restaurants, sporting venues and museums. But the important point is that even the limited vaccination programme in place in the US has weakened the link from catching the virus to hospitalisations and deaths. The US has decided to live with the virus. The economy will continue to recover. We’d also watch for progress on the two infrastructure bills through Congress as the lawmakers return from the summer recess this week.
UK negative sentiment is overdone
The UK is an even more extreme case, where we feel negative sentiment is overdone. Yes, reported new cases of the virus have risen; and yes, they will rise further as the football season continues, the number of people being told to self-isolate by the NHS app declines, and school holidays end. But the true rate of Covid infections, as measured by the Office for National Statistics’ highly accurate infection survey, has actually been falling in recent weeks and more importantly, the rate of hospitalisations for Covid remains under control.
Reported UK retail sales were undoubtedly weaker than expected in July, but these numbers are volatile, the formula that converts the cash numbers into volumes is deeply suspect, and all the evidence points to continued demand.
Labour shortages are pushing up wages
The problem isn’t demand here but rather supply. Vacancies in the labour market are at record highs, employment growth has been exceptionally strong. Far from the mass job that many feared as the furlough scheme winds down, redundancies have dropped off a cliff. And that shortage of milk reflects a shortage of truck drivers to deliver supplies. Tesco is offering a £1,000 sign-on bonus to new recruits. Many drivers have gone home to the EU and are either unwilling or unable to return.
The truck driver shortages may be extreme, but a similar pattern is evident across a wide range of industries, especially those that previously relied on EU workers. Wages are rising as a result. Once this patten is clear, the Bank of England will have to think about raising base rates; we think this is likely to be sometime next year.
And for all the speculation about whether and when the US Federal Reserve will announce tapering with the Jackson Hole conference this week, the Bank of England is almost certain to stop their QE programme without any tapering, at the end of the year.
Less upside for equities but still set to outperform
Equities have benefitted enormously over the last year or more from the dramatic recovery in global growth and corporate earnings. That sort of upside surprise cannot be repeated. But concerns that growth will stall and earnings will fall are overdone. This suggests that equities should continue to outperform both cash and bonds. Yes, equities fell last week, but they are still up strongly year-to-date and should end the year higher still.
My Macro Webinar is taking August off, but these weekly updates will continue.
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.