Friday 13th August, 2021
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Global equities have seen strong performance in August so far, with European stocks leading the pack. By the close of trading on Thursday, the pan-European STOXX 600 Index was up +2.8% for the month – and the benchmark has made further gains on Friday morning. This compares to a +1.5% month-to-date return for the S&P 500 Index and a +1.0% return (in USD) for the MSCI Emerging Market Index. Having lagged the US and the UK in their initial vaccine rollout, the EU has since made up for lost time and the Old World is now well ahead of the New in getting jabs in arms. Although European economies continue to lag the US (where GDP is already larger than it was pre-pandemic), an open summer and lower rates of transmission among vulnerable groups has been a welcome boost for market sentiment. As outlined in our last newsletter, we are circumspect about the EU’s long-term economic future given structural challenges that have only been exacerbated by the pandemic. But maintaining exposure to European risk during this highly uncertain period has proved profitable for us.
Taking stock of where we are with the pandemic more broadly, it is clear that the ferocious delta variant has transformed the outlook globally, from Malaysia to Mexico. Indeed, it is now widely accepted that herd immunity can only be reached (at least to any meaningful degree) with vaccination rates that are close to 100%. For developing countries, where vaccines have been distributed at an often-glacial pace, this is dire news – and EM assets are underperforming as a consequence. But it is also a concern for developed economies. Many made immense progress in Q1 and Q2. However, vaccine uptake has since tapered off at a level well below that which is needed to escape the interminable cycle of business closures, mask mandates, and social distancing restrictions. And convincing the hesitant minority to get inoculated is now the most important job for developed country governments. European states have made decent progress in this regard (although by no means can they declare ‘mission complete’). But the Biden Administration has a mountain to climb, particularly in red states and rural communities where mistrust of Washington runs in the blood. Cases are rising fast across the country, with more than 100,000 new infections being recorded every day, and the concomitant surge in hospitalisations is almost exclusively taking place within the unvaccinated population. This deteriorating situation is taking some of the shine off the US economic recovery; and, as twitchy investors have begun to take note of Delta’s global spread, cyclical recovery plays (e.g., Airlines) and commodities have suffered. No one expects there to be a repeat of Christmas 2020, but increased restrictions would slow growth and fuel political discontent. And Delta may not be the last ‘variant-of-concern’ to emerge this year. Moreover, the successful rollout of coronavirus booster shots before the winter will require increased uptake of jabs 1 and 2 now. There is no time to lose.
From an investment perspective, the slowdown in vaccination programmes in America and elsewhere suggest that the euphoria of early 2021 was a little overdone. Recent economic data from developed markets has been strong, but there is now clear evidence that the pace of growth in the US is peaking (as would be expected given how fast the economic recovery there has been). Giddy market highs may yet prove unsustainable if the explosion of cases in the US does not abate; and a market correction in the Autumn is a real risk if the Fed begins to taper its QE programme in an effort to ward off inflation (which continues to print at >5% annualised) at the same time as pandemic fears make a comeback. Moreover, coronavirus outbreaks in hard-line ‘Zero Covid’ states like China are becoming increasingly frequent and this is likely to cause trade and logistical challenges for businesses, at least until 2022. Indeed, China decided to lock down its massive Ningbo-Zhoushan port this week after just one positive case was recorded there… As such, we think that the world has not yet graduated beyond the ‘stop-start’ economy that we have had to get used to since February 2020. The outlook for risk is positive thanks to the covid-19 vaccines, but a linear upswing seems doubtful.
That being said, one unambiguously positive development for markets this week is that the US Senate has finally decided to back a USD 1tn bipartisan infrastructure bill. This proposal includes USD 550bn of new spending on physical infrastructure over the next eight years. If spent wisely, this capital injection ought to raise US GDP growth and productivity in the long-term through the fiscal multiplier effect (which would be an unalloyed good). But Senate Democrats have also passed a whopping USD 3.5tn budget resolution bill alongside it to bolster Medicare, social security, and climate change initiatives (with zero GOP support). This seems a little less prudent. Both pieces of legislation will now pass to the House, where Progressives are pushing for an even bigger social spending package in a move that could derail the whole budget reconciliation process. Nevertheless, the physical infrastructure bill at least looks set to reach Biden’s desk and this should help to offset some of the impact of concerns about QE tapering and the spread of the Delta variant over the next few weeks at least.
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