Friday 22nd October, 2021
________________________________________
Following steep losses in September, global equity markets have been on a much sounder footing this month. The recovery in risk appetite has been broad based, with most major indices participating. And it has also been remarkably strong given that so little has fundamentally changed month-to-month. As of the close of trading on Thursday evening, the S&P 500 Index was up +5.6% for the month, while the Euro STOXX 600 Index was up +3.3% and the MSCI Emerging Market (EM) Index was up +3.2% (in USD). This is quite a comeback for equities in the past three weeks! One reason for the buoyant mood is that earnings season is now well-underway, and quarterly results have (for the most part) been well-received by analysts. Wall Street banks in particular have had a bumper season thanks to the revival of M&A and corporate activity, and this in itself shows a growing confidence among business leaders.
However, sentiment in rates markets has been altogether different this month, as DM sovereign bonds continue to sell-off on the same themes that dominated in September. Chief among investors’ concerns is soaring inflation, which has become a global phenomenon. In particular, there is a growing consensus that higher prices will be with us for some time to come (perhaps several years). For example, the US 10Y inflation breakeven rate (which reflects market expectations for average inflation over the next 10 years) now stands at c.2.6%. The current bout of inflation – felt most acutely in rising energy and food prices – is being driven by the strong recovery in global demand amid low inventories of goods, labour shortages (particularly in transportation and other key industries), and general supply chain disruption caused by the pandemic. Although the supply-side factors sound transitory, there is uncertainty over how long any transition period will last, and thus over if and when policymakers should act to avoid the worst effects of spiralling consumer prices. Markets are now pricing in interest rate hikes much sooner than central banks have telegraphed, particularly in the US; as these hikes are brought forward, yields have risen, and curves have flattened resulting in negative returns for government bond holders.
To be sure, most central banks have already made their forward guidance for interest rate policy more aggressive over the last few months, and the gradual withdrawal of QE is now imminent in the US (while other countries are set to follow soon). But forward guidance is still lagging market expectations; and many investors believe that the high priests of monetary policy are in denial about the problem and are dragging their feet. Who can blame them? “Too little, too late” could result in plunging real incomes and household savings before mounting inflation forces an even more aggressive tightening cycle down the line. But “too much too soon” could raise the cost of capital for companies, precipitate a wave of corporate defaults and job losses (which we have so far managed to avoid), and choke off the recovery at a critical juncture ahead of an uncertain winter when covid-19 (and associated restrictions) could return with a vengeance.
The first policy pivot by a major central bank seems to have come from the Bank of England. Following a string of hawkish comments from senior officials, Governor Andrew Bailey warned last weekend that the bank “will have to act” over inflation even if nominally transitory supply constraints rather than excess demand are to blame for rising prices. This precipitated the biggest move in 2Y UK gilts (+13bps) since August 2015. The market now expects a hike in the UK policy rate from 0.1% to 0.25% next month, and for it to reach c.1.0% by the middle of next year. Could a similar about-turn be made by the Fed before too long? Afterall, inflation is already running hotter in the US than in the UK. We think that the market is getting ahead of itself in charting multiple UK rate hikes through the early months of next year, and central banks will continue to err on the side of caution whenever possible. But there is plenty of room for policy error, and as inflation rises so do the stakes of maintaining an ultra-dovish approach.
In the current environment of still-low-but-rising rates and razor-thin credit spreads in IG and HY bonds, we think that there is little value to be extracted from traditional fixed income. Instead, we favour short-dated or preferably floating rate instruments in specific niches that benefit from either a liquidity or a complexity premium (driven by structural features of the securities themselves). In equities, we believe that diversification remains the most important principle given the vulnerability of many markets to rising rates and the frequent rotations that we have seen between sectors, factors, and themes. We also like inflation hedges, such as commodities, many of which directly benefit from supply chain dislocations to boot. And, within commodities, who could forget precious metals – a long volatility inflation hedge that should be a portfolio staple while the pandemic is still raging, and the risk of new variants looms large.
In April's news roundup, we look at some of the key movements and purchases including the return of US investment into the London real estate market to a ten-year high of £2 billion in Q1 2024. We also highlight some recent institutional office acquisitions in London.
In this article Neil Benjelloun, Bedrock’s Head of Private Markets, sheds some light on the growth of VC-funded purpose-driven businesses in solving the world's most pressing challenges. Sharing key insights and takeaways from a live Q&A session he hosted with Cameron McLain, Co-Founder and Managing Partner of Giant Ventures.
It is common to see members of the next generation in their 30s occupy a seat on the board of directors. This is desirable as it’s a very important interaction point with the business or the family’s assets, where they learn about strategy and create the family’s vision for the future. But as with most things, there is a good and a bad way to go about it. In this article, Maria Villax, Head of Family Strategy & Governance at Bedrock explores how next gens can prepare for a seat on the board.