Back to School

The summer is nearly over. Not only has the weather, in the South East of England at least, been typically disappointing for the time of year but the days are now noticeably drawing in and next on the horizon is a return to school. Let’s hope, after the turbulence of the last 2 Covid disrupted academic years, that this marks the start of a return to more ‘normal’ education for all our children.

Back to school usually typifies the end of the summer lull in markets too and, as we move into the final third of another fascinating year in the stock market (aren’t they all), where do things stand and what might we have to look forward to over the balance of the year? As we’re not quite out of the summer lull just yet, this week’s commentary is again heavy on charts.

For starters, markets have made good progress so far this year. The S&P 500 is up 21.7%*, the Stoxx Europe 600 is up 21.4%* and even the FTSE All Share Index is up 14.9%*. What’s also noticeable is the lack of any meaningful corrections thus far. The chart below shows the S&P 500 has now gone 195 days without a 2-month period of negative returns, the second longest streak since the 1960’s.

Whilst at the headline level markets have appeared relatively serene, there have been major changes in ‘leadership’ over the period. In the early part of the year highly cyclically areas such as financials, energy and natural resources led and more latterly we’ve seen a return to strength of growth and defensive areas of the market. These moves have coincided with a significant rise, and subsequent fall, in bond yields, as the chart below, of US 10-year Treasury yields, highlights.

It is also true, as can be seen in the chart below, that economic datapoints around the world have recently been somewhat disappointing relative to elevated expectations.

As best we can tell, we think this economic ‘weakness’ amounts to a modest growth scare over the summer period, caused predominantly by the combination of the global spread of the ‘delta’ variant of Covid-19 and the persistent ongoing disruptions within global supply chains stemming from multiple rolling lockdowns around the world over the past 18 months.

The chart above highlights the extent of climbing Covid cases in select western economies and similar trends are evident elsewhere in the world. Thankfully, vaccine rollouts are meaning the conversion of cases to hospitalisations and deaths is greatly reduced relative to previous waves, however the disruption to economic activity through isolation requirements and increased levels of cautionary behaviour, is likely to have been significant. The next chart below illustrates, using the UK as an example, just how acute supply chain issues have become in some geographies and sectors.

Going forward, we are optimistic that supply chain issues will ultimately be resolved. We are also hopeful that the combination of high levels of vaccination and increased natural protection through infection, result eventually in an ability for economies to function more or less normally, whilst accepting that Covid-19 will likely remain a feature of our lives for some time to come.

Our most likely scenario therefore remains that we are in the relatively early stages of a cyclical economic upswing which, short term issues aside, should persist for a period of time. A few additional charts of interest are included below.

If we follow a ‘typical’ seasonal pattern then economic surprises should start improving soon as the chart above suggests. Meanwhile, US job vacancies have just shot through 10 million as you can see on the chart below.

Additionally, inflationary pressures, to us at least, look less ‘transitory’ by the day. The chart below (Bank of America Merrill Lynch) shows annualised US core CPI change over the last 6 months.

In summary, we think economic activity is likely to reaccelerate again in the near future. We think that, combined with persistent inflationary pressures, will lead to higher government bond yields and a resumption of cyclical market leadership. We are mindful that markets haven’t had a typical drawdown yet in 2021 and that remains eminently possible at any time. However, we are encouraged by the chart below (Sanford Bernstein), suggesting investor sentiment is already relatively cautious, and in any event, our investment horizon is a medium term one and for us the outlook for UK equities, and specifically our portfolio, continues to look extremely attractive.