The latest Kingswood Investment outlook from Rupert Thompson, Chief Investment Officer at Kingswood.
Summary
- A strong global rebound is now underway and should not be derailed by the Delta variant
- Global growth should slow from here but even so remain well above trend into next year
- Inflation has picked up considerably more than expected but a good part of this rise should prove temporary
- Lift-off date has been brought forward but interest rates in the US and UK still look unlikely to be raised until 2023
- The outlook for fixed income remains poor, with government bond yields likely to head higher again
- Further gains in corporate earnings should mean share prices still have some additional upside
- Prospective returns continue to look higher for equities than for bonds and we maintain our constructive stance
- Within equities, we remain positive on the UK and Asia and a variety of specific themes, including climate change
Economic and market outlook
The strong global economic rebound anticipated by the markets is well underway. The US grew at a quarterly annualised 6.5% pace in Q2, a similar rate to that seen in Q1. Meanwhile, following contractions in the first quarter, the Eurozone and UK saw annualised growth as high as 8.0% and 21%, respectively.
The combination of fiscal and monetary stimulus, the reopening of the economies, pent-up demand – be it more now for services than goods – and excess saving are all contributing to the rebound. The global economy looks set to grow around 6% this year, more than recapturing last year’s 3.2% decline.
Even so, doubts have grown recently that the global recovery may not be as secure as first thought. The main worry relates to the rapid spread of the Delta variant. However, at least in the West, the extensive vaccine roll-out has weakened dramatically the link between infections and hospitalisation/mortality. While other countries have not been as gung ho as the UK in re-opening their economies, new restrictions have generally been quite limited.
In emerging economies, where vaccination rates are much lower, the Delta variant poses a significantly greater problem. All the same, while the global recovery may not be quite as strong as first thought, the Delta variant looks very unlikely to derail it. Businesses and individuals have become much better at coping with the pandemic and social distancing/lockdown restrictions.
Growth is likely to slow considerably from the current very strong pace, as the reopening and fiscal boosts fade, but should remain well above trend into the first half of next year. Of course, risks remain. Most obviously, the continuing spread of the virus poses the threat of more vaccine-resistant variants emerging. Vaccines should be able to be adapted although it would take time.
Inflation, however, has been the biggest surprise of late. A spike higher had been expected, both on the back of prices (particularly oil) rebounding from the lows touched a year earlier and supply bottlenecks as economies reopened. But the increase, especially in the US, has been considerably greater than expected. The headline inflation rate is now running as high as 5.4%, while the core rate is up to 3.5% versus 1.5-2% prior to the pandemic.
The big question now is how much of this rise will prove short-lived. Most of the increase has been concentrated in a few specific areas, most notably used car prices, but there are some signs that the upward pressure may be broadening out.
In truth, it is too early to know whether this will turn into a major long-lasting rise in inflation. A key factor will be whether the shortages now being seen in the labour market feed through to a sustained increase in wage growth. The latter would prompt businesses to try and pass on the increased costs to consumers, thus providing the mechanism for the upturn to become more entrenched. A further concern is the bottlenecks in production processes that are causing shortages of a range of manufactured goods.
Inflation has also surprised on the upside in the UK, with the headline and core measures rising to 2.5% and 2.3%, respectively. Inflation is now expected to hit 4% at year-end, before retreating again next year.
