In spite of summer jitters in financial markets, we expect governments
will cautiously normalise monetary policy and global growth will remain
robust. We believe there is further upside for equities, especially in
cyclical sectors poised to gain from economic reopening
As central banks
move gingerly towards
normalising monetary
policy, a delicate
balancing act is under
way. They need to
tighten policy – but
neither too soon, nor too quickly. Indeed,
the flattening of the US yield curve in
June signalled fear that the US Federal
Reserve might tighten too fast, bringing
an end to the economic cycle.
While economic growth may be peaking
in the US, global growth should pick up
in the second half of this year as lagging
regions supercharge growth. Only China is
slowing following a tightening of monetary
policy earlier this year. Even so, it is
unlikely that Chinese credit growth will
be squeezed any further, although the
tightening we have already seen will weigh
on activity for several months to come.
A slow journey
By mid-summer 2022, GDP growth for the
major economies should have normalised at
around 5%, which is still high. Consumption
will remain strong as households begin
to spend the savings accumulated during
lockdowns, and activity will shift from goods
to services. US households alone have
built up $2.6 trillion of excess savings since
March 2020.1
To meet rising demand, companies
will have to boost capital expenditure.
This will come at the same time as the
US continues to boost fiscal spending2
while the European Union embarks on
its Recovery Fund and Next Generation
Plan.3 Growth in the US might slow from
its present heady level but it is hard to
see a global recession occurring in the
foreseeable future.
Another fear is that the Covid-19 Delta
variant will delay reopening of economies.
But as vaccination rates rise, the feedthrough
to hospitalisations and deaths
has not occurred. The UK was the test
case for other countries, and saw the
number of new cases and deaths diverge.
What’s more, 10 billion vaccine doses
will be produced by the end of 2021,4
enough to vaccinate most of the world’s
population by early 2022, limiting the
danger of further lockdowns.
Inflation has been boosted by used
cars, hotels and airfares. But underlying
inflation is not a problem right now: the
US personal consumption expenditures
index is running at only 1.8% year-on-year,
the 10-year Treasury inflation breakeven indicator is at 2.3%, while the Atlanta Fed
Wage tracker is actually falling, which
means that price hikes are not feeding
into higher wages.5
Even so, smaller central banks in Norway,
Canada and the UK are already cutting
bond purchases6 and talking about
tightening interest rates. The Fed is the
most dovish of all central banks, waiting
until the labour market reaches maximum
employment before increasing rates.
Yet tighter monetary policy globally does
not necessarily mean tight economic
conditions, as fiscal policy will remain
loose. The International Monetary Fund
expects advanced economies to run
cyclically-adjusted budget deficits of 2.6%
between next year and 2026, compared
with 1.1% between 2014 and the
pandemic.7
The returning reflation trade
So what does a strengthening in global
growth during the rest of 2021 mean for
financial markets? Surging consumer
spending and the increasing gap between
strong earnings and stalling price relatives
means further upside for equities,
especially for cyclical sectors.
Year to date, earnings have been revised upwards
by 11% across the major regions, the
strongest showing on record.8 Record
earnings have been accompanied by price/
earnings ratio deratings, despite strong
equity markets. Earnings forecasts for
cyclicals have risen, those for defensives
have fallen. This has created an
opportunity to buy cyclical stocks.
European stocks have a chance to
outperform, partly because they tend to
outperform when bond yields rise, as the
market is shorter in duration with fewer
growth stocks. Corporate earnings growth
in Europe could beat our current 35%
forecast, returning to pre-Covid levels by
the end of 2021.
This would be a very
sharp recovery compared to previous
recessions. After the global financial crisis
it took 11 years for European earnings to
regain 2007 levels.9 When Covid-19 broke
out, European earnings had only inched
2% above the 2007 level. Yet Goldman
Sachs, for example, now projects
European earnings will grow by 4% a year
from 2023, which compares favourably to
0.1% a year from 2007 to 2019.
All this suggests that the summer’s
growth fears – and the effects on markets
– are overdone. We look at the market and
think, savings rates remain high, balance
sheets are strong, as are housing
markets, and labour markets are
improving. Further, corporate earnings
are recovering, as is capital expenditure.
Infrastructure spending plans are a big
positive. Why should economies slow?
We expect growth will remain strong
over the next 12 months, as monetary
and fiscal policy slowly return to normal.
Equities should continue to outperform
bonds, even though they are not
especially cheap.
Surging consumer spending and the increasing gap between strong earnings and stalling price relatives means further upside for equities
