A fleeting phenomenon
A handful of categories are seeing outsized price gains, which is driving overall inflation higher. They include goods and services that are suffering from supply shortages (such as cars) and those which were hit very hard during the pandemic (such as airfares). We expect demand to return gradually to its pre-pandemic level and bottlenecks to ease, resulting in more moderate price increases over the second half of the year.

There has been some concern that central banks could remove their support if inflation picks up further. More recently, investors appear to be confident that it will be a temporary spike and bond markets have settled down. There has been a general improvement in sentiment as economies around the world continue to reopen. The good news has propelled stock markets in the US and Europe to new highs, and opportunities for further price appreciation remain.

A strong recovery rally has already driven risky asset prices substantially higher from their 2020 lows. Yet the environment should support further gains from equities and higher-risk bonds.

We’re remaining overweight in US and UK small cap stocks, which should benefit from strong earnings growth, as well as Asian high yield and emerging market bonds, which are supported by attractive carry.

US dollar-denominated bonds offer advantages over euro bonds and we’re maintaining our overweight position.

The main risks to our outlook include a sudden cooling of economic and corporate earnings growth as well as potential policy mistakes.

The Covid-19 pandemic is receding in the US, UK and euro area, where the daily rate of new cases has fallen to below 10 people per 100,000. New variants could throw the recovery off course, and the UK’s infection trend has turned higher recently. However, the vaccines appear to be resistant to these mutations and widespread vaccination programmes suggest further lockdown measures will be unnecessary – even if removing them fully is delayed.

As economies reopen, mobility is picking up rapidly, and both the UK and the rest of Europe are catching up with the US. The improvement is triggering a sharp pickup in discretionary consumer spending, supported by policy stimulus. The purchasing managers’ indices for services is now recovering strongly and manufacturing activity is also picking up. Despite supply bottlenecks in some sectors, ample spare capacity in the overall economy points to improvement ahead.

US wages have picked up recently, but the increase is slowing as jobseekers re-enter the market. Low-skilled workers are in short supply because people are still worried about catching the virus and can command a higher premium. For example, there are reports that Amazon is paying sign-on bonuses of up to USD 1,000 in many locations. As the vaccination programme progresses, the economy reopens further and government subsidies are discontinued, these shortages should ease and pay pressure diminish.

The 2020 European Football Championship has kicked off and even though it’s taking place a year later than planned, the crowds are back. It’s just one of the signs that vaccination programmes are working, lockdowns measures are easing and our economies are reopening for business. The final stage of recovery is often the hardest and we’re likely to have to wait a bit longer before all the restrictions are removed.

Financial markets could become more volatile if investors worry that strong economic data and inflation spikes will encourage central banks to change their policies. Yet we’re more optimistic and believe they will continue to support the recovery. You can read about our long-term outlook in our Counterpoint 2021 Mid-Year Update or watch a replay of our recent client webinar.

The economic recovery is gathering momentum, with consumers and businesses unleashing pent-up demand

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COUNTERPOINT 
JULY 2021