The global economy continues to recover and most countries have now rebounded from the worst effects of the pandemic. Corporate results have generally been good and policy remains supportive. The IMF expects global growth to average a 4.5% in 2022, a reduction from the anticipated 6% for 2021. Although economic growth has slowed since the start of the year, it is still relatively strong compared to pre-pandemic trends. Consumers were forced to save during the pandemic and many used the opportunity to pay down debt. As a result, household finances are the healthiest they have been in decades. In addition, unemployment rates are low and wages are rising across many industries.
A question on all investors’ mind is inflation, which is proving more stubborn than central banks had envisaged, as supply shortages and higher energy costs feed through into retail prices. The market still anticipates price rises to moderate over the next six months. However, I believe this ‘transitory’ period may prove optimistic. Although Central banks are preparing to end their stimulus programmes and raise interest rates, demands for higher wages, accompanied by historically loose fiscal policies and flexible central bank mandates all suggest a more sustained period of inflation. Longer term, rising energy costs and constrained labour supply that lead to rising wages could prevent inflation from falling back to pre-pandemic levels. Demand for oil is also expected to increase over the next 10 years at the same time that oil companies are being discouraged from engaging in new exploration. Compared to fossil fuels, alternative, greener energy sources are likely to be more expensive in the initial stages, given the heavy investment required, fuelling further prices rises. In this context, it is worth noting that mild inflation is not to be feared, as long as it is accompanied by sufficient economic growth.
There are also many finely balanced points of geopolitical tension. US relations with both Russia and China have deteriorated over recent months. Washington is seeking support from counterparts in Berlin and Brussels for a boycott of Nord Stream 2 should Russia invade Ukraine. A reduction in elevated natural gas prices in Europe seems contingent upon increased supply from Russia, which the Kremlin has tied to the pipeline's completion. Moreover, the presence of Russian forces along the Ukrainian border is, in itself, a source of concern and recent talks between Biden and Putin have done little to alleviate it. Meanwhile, the growing tensions over the status of Taiwan is the latest sign of deteriorating relations between the US and China. Both are determined to reduce any trade or technology interdependence and China perceives Taiwan as a breakaway province to be reunified with the mainland. The US has stated that it will come to Taiwan's aid if it is attacked. An escalation of tensions in these regions could cause investors to adopt a more defensive position and Gold would likely benefit.
In China, we continue to avoid portfolio exposure to directly listed equities. A less effective COVID vaccine and caution over ongoing state intervention in the private sector have combined to cause the Chinese equity market to further diverge from other global markets. Indian equities have been one of the biggest beneficiaries of overseas investors retrenching from China. Projected Indian GDP growth of 8% for 2022 stands out, especially as China’s numbers continue to be downgraded. For many emerging economies however a stronger dollar and weaker China will be challenging. This is likely to create a further divergence when compared to the developed world and we have maintained our underweight position to emerging market economies.
The pandemic, despite its economic damage, has undeniably accelerated the adoption of technology. The Glasgow Climate Pact, an agreement that reinforces efforts to limit global warming to 1.5 degrees Celsius, agreed at COP 26 feels like a distant goal already, given the balmy 14 degrees temperature on New Year’s Eve. The conference was also notable for the commitment made by the US and China to cooperate more closely on climate change, and for multilateral pledges to phase down coal usage, cease public funding of fossil fuel projects, cut methane emissions and reverse deforestation. Electric vehicles also remain a priority for China and the US. China has already introduced widespread incentives for manufacturers, effectively subsidising the entire industry in the country, and it has made significant strides as a result. Unsurprisingly, this has triggered a response from Washington, including introducing one of the most generous consumer subsidies in the world; the US-China battle for technological supremacy looks to have many years to run. With policymakers agreeing to reconvene in 2022 with tougher emission reduction targets, it is evident the shift towards electric vehicles, low carbon economies and the expansion of renewable energy is gathering pace. Given the recent policy focus, we continue to believe the transition towards cleaner, low-carbon economies will influence investment returns for many years to come.
I remain cautiously optimistic about the impact of ongoing coronavirus outbreaks but think it is more important than usual to be selective in both country and stock selection, focusing on well-run businesses that we feel have leading market positions in sectors that are less sensitive to economic cycles, however, future returns from equity investments may not be as high as those seen in the last twelve months. With all this in mind, it would seem premature to cut equity allocations in the face of strong economic growth; it remains important to focus on those companies with strong balance sheets and high quality business models, where growth is supported by long-term themes and with the calibre of management to adjust quickly to more testing operating conditions. This approach should continue to fare us well over the long term.
Charles Bathurst-Norman, Investment Director
The value of securities and their income can fall as well as rise. Past performance should not be seen as an indication of future results. All views expressed are those of the author and should not be considered a recommendation or solicitation to buy or sell any products or securities.
