Market Pulse | Goodbody Wealth Management

• Inflation was centre stage last week with the core figure in the US just missing the 5% level. For once it was not higher than expected, and that was a bit of a relief. The other positive that was taken from it was the decline in the month-on-month rate i.e. we are passing the peak.

• The Fed meets this week and the expectations are that it will announce accelerated tapering, with net buying to be completed by March next year, and that the ‘dot plot’ will be brought forward by a couple of quarters. Expectations have moved to a relatively aggressive statement from the Fed. Post the ‘Powell pivot’ of the week before last some of the investment banks have revised their interest rate forecasts.

• As we approach year end the background remains equity friendly. Earnings are still being revised upwards. These have been acting as the perfect inflation hedge -as inflation has been accelerating in the second half of this year so has earnings growth. The Q4 reporting season will be kicking off in 4 weeks and the signs are that it will be another very strong quarter. In China the authorities are beginning to implement policy changes instead of just talking about them.

• The Powell pivot became the major talking point last week. During his testimony to Congress he said that the Fed does need to talk about a faster rate of tapering. He also pushed inflation concerns up the agenda. No doubt part of this was in response to the White House putting tackling inflation as a priority. As a result, there was a meaningful increase in interest rate expectations over the week.

• The encouraging thing from last week was the reaction of the fixed income markets. Our fear has always been that as we moved towards normalising monetary policy, there could be a lot of volatility in the bond market which would undermine all asset classes (an interest rate scare). That did not happen last week. Yes, there is a bit of pain in the short end but longer dated yields fell and that is what is important to other asset classes.

• Of course, Omicron is in the background and there is risk that its spread causes dislocation in the global economy. Perhaps this is what the bond market is thinking. One problem with this thinking is that if the dislocation does become significant then monetary tightening probably goes off the agenda. The Delta variant did cause some turbulence in the global economy and in equity markets but the growth rate remained high and the impact was short lived. Using that as the ‘playbook’ it says stick with your long-term strategy and that is what we will be doing and looking at last week’s reaction in the fixed income makes us a little bit more comfortable about that.

• Covid and the new variant will be the main focus in the short term. The reopening theme was already under pressure as infections were rising rapidly in Europe and this gained further momentum on Friday with some very extreme moves in prices.

• This should not impact too much to views on asset positioning. Policy makers will remain very supportive, which is important, and the experience with the Delta variant has been quite benign. Friday was a shortened trading day in the US but the equity market it saw the second largest daily inflow this year from retail investors.

• The equity mix is the more pertinent question and the hit to the reopening trade is a painful journey. But it seems like a lot of bad news has been priced in now so without some firmer information it would be difficult to add value reacting to the developments.

• Last week we were still getting good indications on economic performance. The US is still leading. High frequency indicators (restaurant bookings, passenger traffic, credit card sales etc) were all back to new highs for this year. In fact, it looks like we are back into an upgrade cycle for the US economy although that should not last too long. There were also indications that China would start more efforts to support the economy Premier Li called on the provinces to step up infrastructure spending and the PBoC said it would be doing more to stabilise the credit market. The global economy looked set to have a quite strong finish. This was feeding into earnings as well. We are still getting upgrades, even in the euro area where the outlook has become most clouded. Earnings growth for 2021 was pushed up 1% over the last week. The environment remained very equity friendly.

• Covid became the story that the market was once again following closely last week, with a rise in infections in Europe. Reopening stories were under pressure and the return to normality for these companies looks likely to be impacted. The markets also saw the shift to quality within equity markets, which is due to how companies are managing the cost and supply pressures which they face.

• Many Investment Banks are producing their outlooks for 2022, including Bank of America where it has turned aggressive on the timing of interest rate rises, with an interesting feature of it forecasts being the pace and the peak. It is expecting a 0.25% increase in Fed Funds per quarter and the peak to be between 2.0% and 2.25%, which can result in a benign interest rate cycle. There is not much expectations for downside left in fixed income markets and little disturbance for equity markets.

• It was a better week for data with very encouraging figures from the US. Strong figures within retail and industrial production, as it could indicate that we are passing the worst in the impact of supply chain rigidities. It was a flat week for index levels, and this was the US statistics that came in strongly and will offset any turbulence in the EU area which will push us on into 2022.

• Economic data last week was dominated by the CPI release in the US showing continued inflationary pressure in the US economy. Market reaction was relatively muted. A lot of this relatively calm reaction is probably due to the Fed saying it will not be making any judgement about how permanent the inflation pressures are until the middle of next year.

• We think that we will see a peaking in the year on year growth rate in the global economy as the reopening impulse fades in Europe and the US plateaus from its Delta variant rebound. As we travel into 2022 economic growth will remain elevated but at a slower pace than we are experiencing now. Thus, we feel it appropriate to move some more of our equity exposure to mid-cycle type names.

• Interest rate expectations faced a reversal last week, with two trigger points being the Bank of England meeting and the Fed’s Powell commentary on how transitory the inflation forces are. This pushes the expected interest rate increases in the US out towards Q4, which gave a spur to all asset markets.

• Q3 earning season continued again last week, with US earnings growth coming in at 40% year on year, and in the Euro area, we are getting 50% year on year earnings growth. They are not as strong as they have been in previous quarters, which is coming from very strong sales growth. Companies are facing supply chain issues and cost pressures, however demand is very strong that they are able to cope with pressures and produce results.

• This all leads to a positive outlook for the end of the year, which is motivated by the US economic performance, calm fixed income markets and an earnings story, with a potential for upgrades. The market may face disruption from China and closer to home via ongoing UK-EU negotiations.

• October was a very strong month for equity markets but there was a large regional bias. Developed Markets did far better than Emerging Markets. Some of this is due to the uncertain outlook for China both in terms of growth and policy and some of it is due to sporadic lockdowns due to the pandemic.

• The most striking feature over the last week was the movement in longer dated bond yields in the US and the euro area. For maturities between zero and ten yields there was still upward pressure on yields but at maturities of 20 years and more yields declined by 15bps in both regions. This was driven by expectations of interest rate increase being brought forward into 2022 – we think this is too aggressive.

• For equity markets it does re-enforce the need to be moving towards mid-cycle type exposure. While October was a month for cyclical exposure, that did fade during the last week and one saw the higher rated parts of the equity market beginning to perform, quicker than we would have expected. Last week reinforces the view that we should keep our portfolio preferences biased towards structural and sustainable growth (Healthcare, IT, Services, Consumer) and away from companies and industries that are reliant on the level of economic growth (such as Materials, Manufacturing).

• We got inflation updates from the US which were also somewhat encouraging. Both CPI and PPI came in below expectations. In the CPI report we did see some of what we hoped were transitory pressures (Travel and Lodging, second-hand car prices) subside. On the other hand, there is upward pressure on property costs which will be more sustainable. So, we are likely to have a higher level of inflation but not at some of the extreme levels we have seen in recent months.

• China is a bit more mixed. Q3 GDP missed forecasts as did Industrial Production but much of this occurred in September as power outages spread. So, the weakness is not due to lack of demand. On a positive note, Retail Sales accelerated in September as the number of lockdowns declined.

• The reporting season will capture more of the headlines over the next few weeks and the start has been promising. The consensus forecast is that Q3 earnings for the S&P 500 will be up 30% YoY, 11% higher than at the start of the year. Even over the last four weeks this was increased by 1.6%.

• What we have seen over the last week supports our positioning, a strong growth background with easing in inflation pressures translating into very strong earnings growth. Equities benefit and bonds remain reasonably well behaved. What could derail it is the rampant energy prices and power supply issues. Governments seem alert to the potential growth impact so policies will be implemented to alleviate income pressure from the higher prices. Supply response has been muted so far but that could change and normally does.

• The third quarter was more subdued than the previous ones. Equities ended the quarter on a weak note, but still eked out a small positive return for the full quarter. Bond markets also had a tougher end to the quarter delivering a flat performance for the overall.

• This quarter was the first this year where GDP forecasts for 2021 were reduced. Global GDP growth was cut from 6.0% to 5.7% driven by cuts to US and Asian forecasts as the Delta variant impacted on consumption and production in Asia. Profit expectations remained robust with 2021 earnings growth increased from 39% to 48%. Europe saw the biggest upgrades and by sector it was again Industrials, Energy and Materials that led the way.

• Some of the factors dragging on markets in late Q3 are likely to reverse or have less of an influence through Q4. Rampant energy prices could undermine this and this remains a concern but any easing in energy prices here would clearly be a major positive.

• There were three issues on peoples mind coming to the end of the quarter; the main issue being the Fed’s announcement in November about the tapering time table. This has driven bond yields up and 10-year yields to rise between 10 and 20 basis points, putting pressure on equity markets. Both the fixed income and equity markets have been unsettled with China’s Evergrande, would it cause financial contagion? Lastly the spike in energy and power prices has fuelled the inflation pressure around the globe.

• Asset prices are lower, previously there was possibly an element of complacency. Other developments have made us more comfortable. If we travel back to August, we would have worried about the Delta variant disrupting economics, however the releases for September show the Chinese and Asia X China PMI’s back at or above 50, moving back to expansion territory. In the US, a strong Manufacturing ISM and improvement in data such as restaurant bookings and credit card transactions shows the with the economic background looks better than the previous month. The Q3 reporting season should give some support as sentiment is fairly low at present

• Portfolio strategy remains overweight equities as economic expansion in place. News of the Delta variant slowing and news of a possible oral antiviral treatment gives another boost to the reopening. Developments have been positive and support an equity orientation asset allocation.