In our opinion, there is upside ahead to the global equity markets. We are at the phase between early-stage recovery and mid-cycle stage normal economic growth. This is a phase where global investors are rebalancing and having a look at repricing market premiums across and within asset classes. We are in some form of market gyration from these actions, and we have been saying for a while that the way forward is to diversify well in various forms in our previous newsletters.
Forecasts for booming economic growth have been brought forward into the first half of this year, and financial markets have rotated, at times abruptly, from last year’s winners into more economically sensitive sectors. With this acceleration in growth, it is natural to expect inflation to rise as well. We shall spend some time discussing the global inflation picture on how it would impact the global markets this year.
Rapid price increases could trigger all sorts of problems. For a start, just the fear of central banks raising interest rates could cause a sharp correction in financial markets given that the global economy is still on “crutches”. There are 2 distinct forms of inflation. One is induced by supply/demand imbalances in the global economy and the other is induced by the financial markets.
At present, the rising inflation rates we are seeing is due to pent-up demand fuelled by excess savings and stimulus money as well as inventory restocking even as various bottleneck issues are disrupting supply. Examples of these issues manifested in the form of chip shortage, port congestion and container shortage. Prices of oil have recovered while those for other commodities too have recovered from stronger demand and liquidity-induced speculation.
There are now ongoing efforts from all quarters in resolving these issues relating to supply/ demand. Firstly, China announced a crackdown on commodity price violations on companies, and this has resulted in the cooling of key commodity prices in recent trading sessions. Secondly, the shortfall in the level of payroll growth, indicates that there is still slack in the employment situation in the US. Thirdly, there is also a lot of excess capacity outside the US. In these circumstances, excess demand in the US will simply go into higher imports of goods from the rest of the world. Lastly, given the disruptive trends we have experienced in the last few years, we should continue to expect productivity enhancing techniques which have a deflationary effect on the final product pricing, hence tempering inflation. We are of the view that recent inflationary pressures will prove temporary, and it probably also explains why Federal Reserve officials will hold the line on their ultra-easy monetary policy.
On the other hand, inflation induced by financial markets is distinguished with looseness on the monetary and fiscal fronts. We can probably see easing in the US/Europe in some form or another, but China is already beginning to adopt a tighter policy stance. Financial market assets are volatile and fickle. With low interest rates and plentiful liquidity in the system but without any sign of sustained economic pickup, there may be a risk of speculative excesses and unsustainable valuations. We are vigilant towards this second form of inflation (induced by financial markets). So far, we believe this risk factor is still low and remote.
In the latest Federal Reserve meeting, the officials are signalling that interest rates will rise sooner than expected. We believe this is a natural course at this stage of the market and economic cycle. A higher inflation, coupled with more normalised liquidity and interest rates cycles should also normalise in tandem with the stronger US economic growth.