Strong economic data reinforces the recovery, but supply bottlenecks emerge
March witnessed a push higher in global equity markets, with some US and European indices going on to set fresh highs in early April. Economic data continued to support the recovery theme as fourth-quarter growth in the US and UK came in stronger than expected, reinforced by Purchasing Managers Surveys reflecting a sharp rise in output, new orders and employment. Notable side-effects of this surge in demand, however, were supply bottlenecks and a sharp increase in costs across industry.
A broad advance in equities, with the US leading the way
In sterling terms, shares in the United States rose by 5.7%, the UK and Europe gained between 4% and 5%, and Japanese and Asian markets edged 2% to 3% higher. UK government bonds were flat, although the reflation narrative pushed index-linked bonds a touch higher. In the UK, business optimism hit a seven-year high, underlining the strength of the improving outlook.
Government bond yields rose further during the month, but when the US 10-year benchmark briefly hit 1.77% buyers stepped in, feeling that sufficient future inflation had been priced in for now. Heavy demand for US bonds gave a brief respite to the weakening dollar, though this had since disappeared with the yield falling back to around 1.60%.
The Fed upgrades growth to 6.5% while holding rates at zero
The monthly meeting of the US Federal Reserve Board upgraded its growth forecast for 2021 from 4.2% to 6.5%, while maintaining its projection for near-zero interest rates through 2023. Despite the addition of over 900,000 jobs during March and annual inflation jumping to 2.6%, Chairman Powell commented that it would likely be "some time" until substantial further progress toward the maximum-employment and price-stability goals would be realised. The Fed's new mandate is to target an average inflation rate of 2%.
President Biden announced the broad outline of his $2.2 trillion infrastructure plan, including proposals for cleaner water and high-speed broadband, to be financed by an increase in the corporate tax rate. The complexity of negotiations, and the possibility that the package could be broken into several parts, meant that lawmakers did not see completion until the autumn. The programme was then expected to be rolled out over the following eight years, suggesting a steady rather than parabolic impact on growth.
Rising industry prices raise the question of how lasting inflation will be
The US inflation figure for March was the first to reflect the bounce in the oil price from the previous year's collapse, with the expectation that it would rise further during the year. Core inflation, which strips out food and energy prices, remained subdued for now. Bond yields fell on the release because it was felt that current yield levels had already allowed for this adjustment and a bit more going forward.
We need to be mindful, however, that global Purchasing Manager surveys and anecdotal evidence were consistently pointing to rising prices throughout industry. Factories were reporting higher costs, reflecting rising commodity prices and supply shortages. This increase in costs had fed through to the steepest rise in average selling prices for goods and services for over a decade. In part, company profit margins were bearing the brunt, but US consumer goods producers reported the largest rise of all major goods and services product sectors ever recorded.
It was too soon to tell whether these costs would be transmitted through to consumer prices, and there was certainly an argument that a period of above-average inflation would prove only temporary and be tolerated by central bankers. What concerned us, however, was the change in the Federal Reserve's approach. In recent speeches, members of the Fed had made clear that their policy decisions would be based on outcomes rather than forecasts: they would wait until they saw inflation rising and the jobs market tightening before taking action. For years, a key central bank principle had been that it takes up to two years for policy decisions to feed through to the market, so by the time inflation or employment had printed at a level consistent with the Fed's mandate, acting at that point would arguably be too late.
A note from the desk
I am pleased to share our monthly update on market events. The overview seeks to summarise market movements together with our views and the rationale for the positioning of investments going forward. As always, should any aspect of this commentary prompt a question, we would welcome the conversation.
Martyn Charlwood · Managing Director
Central bankers face an unenviable dilemma
The challenge for central bankers is a delicate one. By persuading investors that they would not allow a collapse in asset prices, they had created a situation in which they faced difficulty regardless of their next move. Hints that they might tighten policy could lead to a panic sell-off on fears that the "free ride" was over, but failure to act on stronger data would raise concerns that far higher rates might eventually be required to rein in inflation.
We feel that market positioning and pricing continues to reflect a very optimistic view, punctuated by bouts of volatility as this view is called into question. With short-term interest rates likely to remain at record lows for some time, we will view these setbacks as further investment opportunities.
By the time inflation has printed at a level consistent with the Fed's mandate, acting at that point may be too late.
The question of timing is central to the outlook. Global Purchasing Manager surveys and anecdotal evidence point consistently to rising prices throughout industry, yet core consumer inflation remains low. Whether these cost pressures will prove temporary or become embedded is something only time will tell, but the shift in the Fed's framework, from acting on forecasts to waiting for outcomes, introduces a risk that policy may lag behind events. For now, the recovery remains well supported, and we continue to look for opportunities within a market that is pricing in a great deal of good news.
Portfolios were rebalanced last year in anticipation of a more inflationary environment, so no further action has been needed in 2021. Our positioning continues to reflect a preference for undervalued areas of the market and broad diversification across asset classes.
Limited exposure to rising bond yields
Our fixed interest funds continue to have limited exposure to rising yields, as we feel that current levels do not offer sufficient reward for the potential risk of capital loss.
A blend of value and growth, with caution on US mega caps
We are holding a mix of value and growth stocks but have sought to minimise exposure to US-listed FAANG names, where valuations have become excessive. Our value stocks have continued to enjoy a strong recovery so far this year.
Alternative assets for diversification
Our portfolios diversify risk by investing in a wide range of assets using actively managed funds with sound investment processes. Examples of these alternative assets include funds invested in gold and silver, infrastructure, agriculture and absolute return strategies.
Important information
This article is a marketing communication intended for general information only. It does not constitute personal advice, a recommendation, or an offer to buy or sell any investment. If you are unsure whether an investment is suitable for your circumstances, please seek personal advice.
Past performance is not a guide to future performance. The value of investments and any income from them can fall as well as rise. Capital values are at risk and not guaranteed. Forecasts and views expressed in this commentary represent our assessment at the time of writing and are subject to change.
To discuss how this commentary applies to your own portfolio, we would welcome a conversation.
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