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Market Insights – October 11, 2021

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

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Essentials

Even though the US added fewer jobs than expected in September, unemployment continued to decline, dropping to 4.8%. This improvement in the labour market makes it all the more likely that the Fed will begin tightening monetary policy soon.

After bouncing back in July, Germany’s industrial output dropped sharply in August, down 4% on the prior month. This decline was mainly attributable to the shortage of parts, particularly in the automotive sector, where production has plummeted. Based on the latest PMI figures, the worst of the bottlenecks could now be over.

WTI crude has continued on its uptrend and passed the USD 80 per barrel mark. It’s currently at its highest level since 2014, as supply struggles to keep up with demand.

USA: After the euphoria

The growth peak we wrote about in the early summer has now been reached. US GDP growth has started to stall, and so have activity indicators, consumer confidence and employment. If you’re optimistic, you might say that this is a healthy return to normal levels after a period of record expansion. But if you’re more pessimistic, you could say this slowdown is not good news for the US economy. The reality is no doubt somewhere in the middle.

It’s true that with the economy slowing, companies will find it harder to exceed expectations, although earnings growth is still well above its long run average. Close to 90% of S&P 500 companies beat – and in some cases thrashed – consensus forecasts during the Q2 earnings season. But that figure has almost certainly passed its peak, and there should be fewer positive surprises in Q3.

Unfortunately, investors will have more to worry about than economic growth as we enter the final quarter of the year. Inflation is soaring, the manufacturing sector is experiencing bottlenecks, and the Fed is very likely to tighten monetary policy – all factors that could weigh on the stock markets. US stock multiples are still surprisingly high given that interest rates are gradually rising. We would welcome a return to more normal levels, so that we can move back into the US market with more confidence.

In this climate, we are maintaining a relatively cautious stance on US equities, which are currently less attractive than stocks in some other regions. Our sector allocation reflects this conservative approach: we prefer stocks that offer both stability and visibility over highly cyclical ones.

Bond yields start to normalise

The sharp uptick in growth has put supply chains under strain. Raw materials and finished goods inventories are dwindling, freight rates have soared and many sectors in industrialised economies are struggling to find the labour they need to meet demand. All of this has caused another rise in inflation, which central banks had insisted would be transitory. We’ll have to watch this space – while consumer price indexes flattened, there still seems to be pressure on upstream prices. What’s more, wage rises appear to be looming in the States, which might cause second round effects.

We therefore wouldn’t be surprised if inflation is more persistent than initially expected in the US. This would prompt the Fed to review its optimistic inflation scenario and perhaps even to speed up its monetary policy normalisation. That could, in turn, lead other central banks to do the same. The expected tapering of asset purchase programmes in the months ahead will almost certainly push up long-term interest rates – in fact this trend may already be under way, given the upward pressure we’ve seen on yields since August. We are therefore continuing to have a cautious approach in terms of duration, and we still recommend investing in US inflation-indexed bonds.

 

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