A time of transition 

 

The global economy is currently affected by a number of mid-sized shocks within a slowing global economic rebound. The midsized shocks are: 1. The feedback loop from a surge in inflation including supply chain disruptions 2. An economic slowdown in China 3. The spread of the Covid-19 delta variant 4. Brexit and 5. A deterioration in Pax Americana. For now, the market is largely ignoring these. But realism should eventually dawn as consumption eventually slows somewhat, delaying the speed and intensity of Fed and ECB bond tapering. Even this week the ECB might announce a slowdown of the Covid-19 bond purchasing program. For sure, the global economy is slowing down and this for a few months at a faster pace than expected, but we remain in a solid global economic rebound. As realism sets in, it should simply offer better entry levels in the equity market.

1. The feedback loop from elevated inflation
Consumer expectations especially in the United States have been dampened by elevated inflation. Surveys suggest consumers will tend to be reluctant to buy cars or housing at these elevated prices and at a time when real wages are negative and savings slowly ebbing. Low inventory might in any case be a substantial issue. That should lead to more moderate consumption in the next three months, while supply chain disruptions could last into the first half of 2022. Only some of this seems priced into equity markets.

2. An economic slowdown in China
The Chinese economy is steadily slowing down encouraging the market to expect easier monetary conditions, possibly a weaker renminbi and less pressure to deleverage various sectors such as the real estate market. A multiplicity of factors are behind this slowdown from the Covid-19 delta variant, to flooding, supply chain disruptions, nascent carbon controls, a crackdown on monopolies as part of a new official narrative or an expensive real estate market. The authorities are likely to quickly change course to support economic growth including targeted cuts to banks’ Required Reserve Ratio. In the short-term, the risk is of a default by the real estate company Evergrande in a credit market already under strain.

3. The spread of the Covid-19 delta variant
The spread of the delta variant hurts countries and states with low vaccination rates such as Bulgaria and parts of Emerging Markets. In addition, we may well find that some countries benefited from vaccines with low efficacity against new variants. Everywhere this is keeping workers away from work, hurting industries such as restaurants. A new, more dangerous, variant can also not be excluded – such as potentially Mu. As fear spreads and measures are taken, the vaccination rates have tended to increase e.g. France. A look at airline stocks suggests this is already partially priced in as the market anticipates an eventual partial normalization.

4. Brexit is not on the whole a complete success
Brexit is a shock primarily for the UK but also to a lesser extent the EU which exports to it. Supply chain disruptions seem somewhat severe as importers prefer to ask for special visas for EU immigrants to drive trucks rather than raise very low wages indicating a lack of competition. As we head into Christmas, the impact of Covid-19 with supply shortages looks set to be potentially severe, but let us be optimists.

5. A deterioration in Pax Americana
This deterioration is a process that precedes the Trump administration. As fear ebbs, the cost of war rises and economic growth is average for a majority of voters, there is a tendency to withdraw back to home and look weak and feeble to autocracies. This and the consequence of the debacle in Afghanistan makes it more difficult to achieve common goals such as the United Nations Climate Change (COP26) which is not going well.

What does it mean?

Optimism abounds in segments of the European and especially US equity markets beyond what the economy will eventually deliver over the long-term, and some disappointment is ahead of us, especially as discussions of tapering make some progress in the United States and Europe. Indeed, the US non-farm payroll was a disappointment last Friday though much of it can be assigned to Covid-19 and mobility data shows an improvement recently. However we believe that disappointments only offer better levels in which to enter long positions in equities. We continue to prefer a diversification across style and the flexibility of multi-asset solutions. Long-term, we watch the real estate market as a key risk, a point the Swiss National Bank has made recently.

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