A drop in infection rates and the progress of vaccination rollouts have continued to support equity markets, the UK and US in particular are progressing well with vaccinating their populations and may achieve a large scale reopening of their economies in the second half of the year. Virus mutations could potentially slow down a return to normality, but there is optimism that any new strains will not be vaccine resistant.
Continued fiscal and monetary support has meant that in spite of the need to maintain social distancing measures, any impact to the economy from ongoing restrictions should be more limited than during 2020. The approval of President Biden’s huge $1.9 trillion fiscal stimulus programme will provide further support for the US recovery, although government spending is creating some concerns around potential inflation and government bond yields have risen as markets price in higher future growth and inflation expectations.
World equity markets have generally made some progress so far this year despite a drop towards the end of February on the inflation concerns referred to and stronger performance from smaller and more economically sensitive companies has continued as a result of the expected post pandemic economic normalisation and rising bond yields.
The additional stimulus package approved by the US Congress could lead to a significant acceleration in consumption particularly when restrictions are lifted, but may also create inflationary pressures although after the lockdown related base effects, which will inevitably mean higher annual prices from last year have run their course. The Chair of the US Federal Reserve, Jerome Powell, has indicated that headline inflation is expected to fall back, meaning that interest rates would remain near zero until employment has recovered and inflation is at 2%. Markets have yet to be fully convinced however.
While the US and UK have led progress on the mass vaccination programmes the EU countries have experienced delays, resulting in the possibility of extended selective lockdowns. This may restrict the strength of recovery in the shorter term but the go ahead has been given for the €672.5bn Recovery and Resilience Plan which will provide significant stimulus. The formation of a new government in Italy to be led by Mario Draghi the former European Central Bank President saw a favourable reaction from markets.
For the UK, the excellent progress of the vaccination roll out means that the Government’s target of achieving full coverage of the adult population by July and gradually reopening the economy seems achievable. The latest economic data has suggested that retail sales have declined due to lockdown measures but manufacturing and services have been stronger than in the previous lockdowns as there has been adaptation to the restrictions.
Emerging markets particularly East Asian economies, where the impact of the pandemic was more limited, are expected to experience higher levels of growth as the global economy strengthens. China is set to lead the way with growth ahead of the longer term trend although the authorities have talked about withdrawing stimulus measures to avoid overheating.
Expectations for an imminent exit from the pandemic thanks to vaccination programmes continue to be a source of optimism for markets, although new and unpredictable mutations of the virus are a potential risk. Governments are now focusing on the right mix of pandemic controls and support measures to ensure that the period of sustained recovery can be reached without any long term damage to the economy. This is reflected in continued support for business and workers of the type being provided in the US and the Chancellor’s Budget earlier this month.
The risk that higher inflation could materialise in mid-2021, albeit in part due to the year on year changes from last year’s declines in many prices, has fuelled a trend of rising bond yields. An impact on equity markets has been a rotation to areas such as commodities and financials which benefit from rising yields, particularly the latter. This backdrop means that a fixed interest element of portfolios is vulnerable to a higher than anticipated rise in inflation/interest rates and a broad degree of diversification is likely to be important.
|2021 Year to Date|
|FTSE World ex-UK (GBP)||+1.19%|
|FTSE Actuaries UK Conventional Gilt All Stocks||-5.75%|
|FTSE Actuaries UK Index-Linked All Stocks||-5.82%|
Performance to 09/03/2021
|Bank of England Base Rate||0.10%|
|Inflation (Retail Prices Index)*||1.40%|
* January 2021