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Market Insights – December 6, 2021

Each week, our Investment team shares its market views with you.

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Essentials

China’s tech stocks have been targeted by both US and Chinese regulators, triggering a fresh wave of panic and volatility on the stock markets. Investors are worried about the growing risk of Chinese companies being delisted from US stock exchanges. Stocks with a secondary listing in Hong Kong have also been affected even though they are fully fungible in both markets. 

The People’s Bank of China seems to have adopted a more accommodative, growth-friendly stance. It has cut the reserve requirement ratio for banks by 0.5 percentage points as it focuses on stabilising growth in response to its slowing economy. 

Oil prices dropped sharply on news about the new COVID-19 variant. Given that oil fundamentals are still robust, we think the decline is a sign that investors are expecting a swift return to strict lockdowns, a scenario we think is unlikely at the moment.

Powell retires the word 'transitory'

It really was just a matter of time: Jerome Powell, the Chair of the US Federal Reserve, has finally said that ‘transitory’ is no longer the right word for the current spike in inflation. For several months now, the Fed – at the risk of denting its credibility – has insisted that inflation would be temporary because of the strong base effect from the COVID-19 pandemic. It believed that the sharp swings in commodity prices caused by the shutdown and subsequent reopening of the global economy would be short-lived.

Yet some commodities are still hard to come by, and many supply chain bottlenecks remain around the world. With US inflation above 6% over the past 12 months – a rate not seen in 30 years – the Fed’s position had become untenable. What’s more, the US economy is almost back at full employment, so wages have also begun rising, which will, in turn, drive up the prices of goods and services, meaning that inflation will be around for longer. The Fed’s change in stance rattled the markets and knocked investors’ confidence, which had already taken a hit in recent weeks.

The statement suggests that the Fed may be prepared to speed up the process of normalising monetary policy, which might mean that it will wrap up its tapering and raise interest rates more quickly than expected. Although the Fed is right to change its stance, the timing wasn’t ideal – the northern hemisphere is in the midst of a surge in COVID-19 infections and the new Omicron variant is causing concern throughout the world. 

Unlike the European Central Bank (ECB), the Fed doesn’t usually commit flagrant monetary policy errors. If it has to choose between growth and inflation, the US central bank normally makes the health of its economy and its jobs market the priority. Jerome Powell will no doubt look closely at key US COVID numbers before making any drastic changes to monetary policy.

But unless the pandemic takes a major turn for the worse and strict lockdowns are brought back in, the Fed’s shift in tone is likely to prompt US bond yields to rise, which will partly compensate investors for the increase in inflation expectations. However, despite the Fed’s statement, the renewed uncertainty actually caused yields to fall last week.

USA – visibility has been reduced

Stock markets usually rally strongly during the last few weeks of the year, but US equities have been shunned in recent days. Investors seem to be taking every bit of news badly. On the one hand, upbeat data – like the unemployment rate, which continues to decline, hitting 4.2% in November – have prompted speculation about the inevitable tightening of US monetary policy. 

Economists think that the Fed might raise interest rates as early as 2022, and that would put downward pressure on US stock prices, which are currently riding high. On the other hand, less encouraging news – like the new wave of COVID-19 infections – has sparked fears of further restrictions and an abrupt slowdown in economic growth. Although Europe seems to be bearing the brunt of the current wave, the arrival of winter and of new, highly infectious variants means that the US is likely to see a rise in cases in the coming weeks too. 

It therefore comes as no surprise that investors are protecting themselves against all these unknowns, which have reduced visibility on the economy over the coming months. It has been a stellar year for the stock markets, so now is the time to adopt a more cautious stance and lock in the gains recorded so far. That’s why we slightly reduced our exposure to equities – especially US equities – last week.

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