Market and Economic review for week ending 3rd December 2021
Within the LF Prudential Risk Managed Active and LF Prudential Risk Managed Passive portfolios the portfolio manager remains neutral in equities and fixed income, while maintaining a small diversifying overweight to alternatives.
Market and Economic review
After last Friday’s virus induced sell off, equity markets have had a bumpy week. They have been buffeted by Omicron headlines and comments from central bankers, with some large intraday swings. Global equities (in GBP) are roughly flat for the week but there is some dispersion between the main regional indices. UK and emerging market equities have been the top performers, up around 1%, while Japanese equities have struggled, falling by more than 1%. Commentators and flow data suggest that retail investors have been active buyers while hedge funds have de-risked to the lowest level seen in recent months.
Cases of the Omicron Covid variant have been found in over 24 countries. However, there are conflicting views on when it first emerged and therefore how rapidly it has spread. Early evidence suggests that although it is more contagious in nature, symptoms are milder/ more moderate, and that infection is skewed towards younger people. It will be important to see how this early pattern, and the low rate of hospitalisations so far, develop over the coming weeks. We await the results of lab-based tests that will measure vaccine performance against the new strain. The CEO of Moderna spooked markets on Tuesday when he told The Financial Times that he believed there will be a “material drop” in vaccine effectiveness and it may take several months to create the new variant-protection at scale. This is not, however, a view that was shared by other pharmaceutical giants, or the World Health Organisation, who suggest that the current generation of jabs are still likely to be effective and new vaccines could be produced swiftly, if required.
There was promising news in a preliminary report on vaccine efficacy from Israel. It found that the Pfizer vaccine is “just slightly less effective in preventing infection with Omicron than with Delta – 90% as opposed to 95% – while it is as effective – around 93% – in preventing serious symptoms at least for those vaccinated with a booster”. Finally, it is widely believed that the recently developed Covid-19 antiviral drugs will remain effective, and some early tests from GlaxoSmithKline support this theory.
In a testimony to the US Senate Banking Committee on Tuesday, Federal Reserve Chair Jerome Powell was unexpectedly hawkish in the face of the current virus threat. He said that the central bank will discuss accelerating the tapering of its bond buying program at its December meeting, possibly ending purchases a few months earlier than previously thought. He also emphasised the importance of stability in prices, highlighting that inflation pressures “have spread much more broadly", “the threat of persistently higher inflation has grown” and it may be “time to retire the word transitory, regarding inflation". US 2-year bond yields moved higher on the change in tone while the 10-year yield moved moderately lower. The latter may be due to a flight to quality in markets during these volatile times, and potentially a view that the Fed is ahead of the curve now, in dealing with inflationary pressures, meaning there is less uplift pressure on longer dated bond yields. Faster tapering and earlier rate hikes do not necessarily conflict with the notion that monetary policy will remain extremely accommodative, keeping real yields low/ negative and creating continued demand for risk assets.
After a strong October, The Conference Board’s Consumer Confidence Index fell a couple of points to 109.5 in November, slightly below expectations. Consumer concerns about rising prices seem to be one of the primary drivers of the reduction. A measure of U.S. manufacturing rose as factories ramped up production, new orders picked up and firms suggested that supply chain problems may be easing. US employment also continues to look very healthy, with the ADP Research Institute estimating that 534k jobs were added last month. In Europe, German inflation surged to its highest level since 1992, pushing total Euro area inflation to an all-time high since the birth of the single currency. Consumer prices rose 4.9% (annualised) in November vs a forecast 4.5%. Although European Central Bank chief, Christine Lagarde, may face increasing pressure to take action against rising prices on the continent, for now she is sticking to the view that inflation pressures will subside next year.
In the UK, Mortgage lending fell sharply after the pandemic stamp duty tax break expired. 2021 has seen one of the highest volume property markets in the last 20 years, with 1 in 16 homes changing hands in 2021. The emergence of the Omicron variant has clouded the outlook for the Bank of England's December interest rate decision, increasing chances that the much anticipated first rate hike may now be delayed (once again) until next year.
In ESG news, BP has announced plans to build the UK’s largest green hydrogen facility on Teesside. By 2025, the new plant will produce around 60MW of clean fuel to be used in new hydrogen powered lorries and other forms of transport. This capacity is enough to power the equivalent of 1300 large trucks, that currently use diesel, and the output could be increased to 500MW by the end of the decade. The oil major signed an agreement with Daimler Trucks in October to develop a network of hydrogen fuelling stations across the UK.
We continue to look for signs of monetary policy change amongst the Central banks. which we think will continue to be a key driver of markets. While there may be an incentive to keep real yields in negative territory (given the large stock of government debt outstanding), there is also a need to stop inflation getting out of control. It should be noted that yields remain at low absolute levels, meaning that financial conditions remain accommodative. Following the change of Fed rhetoric this week we have seen the curve flatten (mainly through increases at the front end, as changes to the Fed funds rate have been brought forward in time). Absent a significant and fast upward move in the yield curve, risk assets may continue to perform well, despite already high valuation levels, although the risk from potential new Covid related lockdowns is hard to assess.