Reported cases of Covid-19 rose further last week. The wave caused by the Delta variant seems unstoppable so far and is affecting countries that had previously been relatively lightly hit. It is also undermining several governments’ ‘zero Covid’ strategies.
Australia announced a tightening of restrictions and after a single case was discovered in Auckland, New Zealand reinstated a strict lockdown. Faced with unprecedented pressures on its hospital system, Japan has extended its state of health emergency. The spread of the pandemic is rife in the southern United States, where vaccination rates remain low. With little to stem the tide in the foreseeable future, the situation could weigh on the economic agents’ confidence and continue to worry investors.
Less supportive economic indicators in China....
Two important drivers of global growth have shown signs of running out of steam in recent days.
In China, production and consumption data disappointed expectations in July, while activity surveys had already fallen due to new health restrictions implemented to stem the Delta variant. The difficult weather conditions of the summer (floods) may have compounded these difficulties but, beyond these one-off phenomena, domestic demand also remains hesitant. The Chinese authorities’ more accommodative monetary policy in July was a reminder that, as well as pursuing a policy of reducing private sector debt, Beijing intends to prevent any excessive slowdown in activity. We share this view, which is becoming increasingly consensual.
... and mixed in the US
In the US, market sentiment has shifted from relief that inflation is finally in line with expectations after several upside surprises, to concern about the decline in consumer confidence in August and the fall of retail sales in July.
Inflation was 5.4% year-on-year (as in June) and core inflation (excluding food and energy) declined from 4.5% to 4.3%. Increases remain significant in some areas (mainly transport, hospitality and leisure), which are benefiting from the reopening of the economy, but this phenomenon is fading. For some manufactured goods, supply bottlenecks have yet to be fully addressed. Inflation also accelerated on the cost of shelter. Investors and the US Federal Reserve (Fed) are likely to carefully consider this development in the coming months.
Consumer confidence, as measured by the University of Michigan (preliminary estimate for August) was below expectations and significantly down on July (70.2 after 81.2 and 85.5 in June). Indeed, the index hit its lowest level since 2011. This may well have been because the pace of vaccination so far had raised hopes that the pandemic would soon be overcome, only for the Delta variant to come along and shatter that optimism.
Retail sales fell by 1.1% between June and July on the back of a sharp drop in automobile purchases, most likely accentuated by vehicle price increases. Industrial production figures were more encouraging: Manufacturing output rose by 1.4% in July, suggesting that bottlenecks are easing. This may not continue, though, given the restrictive health measures put in place by some Asian exporters.
Magnifying glass or telescope?
Beyond these specific factors, there are conflicting indicators that make it hard to judge what’s coming next, and over what time horizon.
On the one hand, recent news has not been overly good, and the release next week of surveys for August (Flash Purchasing Managers’ Index (PMI) estimates, consumer confidence in France, Italy and Belgium, and the IFO business climate in Germany) should provide some initial indications of the consequences of the resurgence of Covid in Europe.
Conversely, the indices measuring levels of confidence, as well as hard data and inflation, remain quite high.
This might look like a reminder of former US President Harry Truman’s joke about wanting a one-armed economist who wouldn’t be able to say: “On the one hand this...on the other hand that”. But really it is about the hard questions policymakers and investors alike must ask themselves.
How do we look at financial markets?
This question of the time horizon is, perhaps more than usual, crucial to monitoring financial market behaviour. Should we consider the recent drop in global equities (-0.7% between 11 and 17 August for the MSCI AC World index in US dollar terms), their rise of 0.7% compared to the end of July, or the gain of nearly 13% since the beginning of the year?
When investors are perplexed, it can lead to stretched market conditions, low participation, poor momentum and wide dispersion across indices and sectors. Pure technical factors can be a decisive aid to decision-making in the short term. We are integrating these into our asset allocation process and our analysis of them has reinforced our inclination to gradually reduce risk over the summer while maintaining an overexposure to developed equities.
The fundamental factors could become more important after the summer. We still believe that they should support risk assets in the medium term, but more erratic movements could be seen as the consensus settles down, given that the range of possibilities – from stagflation to the return of the reflation scenario – appears to be wide.
Any views expressed here are those of the author as of the date of publication, are based on available information, and are subject to change without notice. Individual portfolio management teams may hold different views and may take different investment decisions for different clients. The views expressed in this podcast do not in any way constitute investment advice.
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