Relief rallies are always encouraging but do not necessarily portray parting clouds for a return to “normal” market conditions. The market is still digesting a rather dizzying array of challenging dynamics that have unfolded quickly over the last quarter.
The Russian invasion of Ukraine has created significant uncertainty for investors. Prior to the war’s outbreak, central bankers were already facing a challenging inflationary environment, and these new commodity-driven price pressures are set to complicate matters even further.
The outlook is currently challenging. Tightening is coming, but it is not here yet and in the meantime current policy remains quite accommodative. There is no doubt that extremely easy policy boosted equity prices, which were reinforced by strong earnings. Still, we believe organic growth can continue.
As is often the case, markets are a better reflection of general sentiment than news headlines and so far, it points to an ongoing global recovery as equities hold their gains of 2021 and long-term bond yields rise. It may not be time yet to write off more difficult scenarios derived from the outbreak of Omicron, but facts so far do speak more positively than just one month ago.
The global outlook still looks positive, but less is known about the potential impact of the latest variant of the COVID-19 virus, Omicron—particularly in light of the fast government response to add restrictions on travel and, in some cases, local mobility.
We maintain a constructive view of risk assets but are cognizant that the path toward realising gains will be more delicate as we traverse the course of the Fed and other central banks removing their easy policies.
Has economic data really changed so much as to suggest an inflection point on inflation and the growth outlook was near? To some degree perhaps, at least in the eyes of the market, but not enough in the end for central banks to meaningfully change their guidance.
Volatility has arisen as we expected it eventually would, and September is often an apt month to rediscover risk given market participants’ return from summer vacations noting that record high equity markets do not quite square with a number of significant risk events on the near-term horizon.
As we contemplate a post-pandemic world, it is becoming more likely that things will not return to “normal” as we once knew it. While vaccines have been highly successful in preventing serious illness in those who are still contracting the virus, the Delta variant of COVID-19 is also proving to be harder to contain.
Cross-asset pricing has recently been challenging our reflationary outlook. When we first discussed the prospects for reflation about a year ago, we identified a number of key factors.
The US and China are likely reaching peak growth as stimulus and the initial burst of pent-up demand begin to wane. In China, while the credit impulse has turned negative—usually an ominous sign—demand continues to normalise, shifting from outsized demand in manufacturing back to normal patterns of consumption with authorities still fine-tuning the extension of credit to the parts of the real economy that need it.
Despite very bumpy economic data—particularly on inflation—rates have compressed, implying most of the “surprises” have already been priced in. This is positive for growth assets that respond better to yield curve stability than the sudden steepening that defined the first quarter.
The US Treasury (UST) market has been an important barometer of the reflation trade for markets this year. Most asset classes have performed in line with movements in UST yields as correlations, whether positive or negative, remain strong.
As reflationary dynamics gain support from refreshed stimulus in the US and a largely successful vaccine rollout with returning growth already to show for it, the reflation trade appears a bit exhausted as measured by market action. However, we see the current dynamic more as a pause than a conclusion.
The strong start to the year for global equity markets hit its first bump in the road in February. While most countries are still delivering a positive return for the year, markets have retreated from their highs to varying degrees.
Markets have become choppy, particularly toward month-end, and we expect more of the same given the nearly unrelenting strong run in risk assets since late March 2020 that gained fresh momentum early in November following the US elections.
2020 will undoubtedly be remembered as the year of the pandemic. While in financial market terms it is now tempting to think of COVID-19 as old news, the virus still presents substantial risks to the economic outlook.
The year 2020 is one most would like to forget, but for markets, performance was particularly strong despite the substantial COVID-19-related economic fallout. Certainly, ample liquidity in the form of massive monetary and fiscal stimulus was a key driver of performance, but near-term optimism may also be warranted. The vaccine rollout could return demand to more normal levels in 2021 and potentially beyond, given the pent-up demand on the back of still-massive amounts of liquidity sloshing through the system.
While economic data is likely to remain soft, driven by the more recent lockdowns in the US and Europe, markets are rightly looking through the near-term gloom as impending vaccines for COVID-19 are showing the proverbial light at the end of this nightmarish tunnel. Over 2021, the world, in our view, should gradually return to some sense of normalcy as the pandemic slowly recedes in the rear-view mirror.
Although some on the committee agreed with the market consensus for a moderate continuation of economic growth and equity markets, and a few were even more cautious, especially regarding increased fears of inflation later in 2021, the majority agreed with a more positive scenario in which the global economy outperforms market consensus, while equities, especially those outside of the US, rally sharply.
With the US presidential election now behind us, the two candidates seem to be proceeding in parallel universes. The apparent winner, President-elect Joe Biden, has transition planning and inauguration on his mind while President Donald Trump continues to challenge the election process itself.
In order to gain a range of perspectives on the US presidential election, Nikko Asset Management has gathered the views of the following experts and investment teams, representing many of our major asset classes and geographical regions.
Coordinated fiscal and monetary stimulus is likely to support global demand and therefore reflation in the years ahead. We see this opening up broader growth opportunities, and ultimately better scope for portfolio diversification.
October 2020 Second and third waves of the virus will also slow the recovery. But importantly, mortality rates have been lower, suggesting that the world continues to learn to live with the virus without requiring broad lockdowns.