When one door closes, another usually opens.

As this is being written, everyone’s attention is riveted on the interest rate expectations – and rightly so, because what happens there is very likely to affect financial markets. The timing and magnitude of interest rate hikes are dependent on the pace of the economic recovery and progress on the vaccination rollouts. Rapid vaccination programs are underway in major economies and global economic growth is expected to be robust in 2021 and unemployment continues to trend down as economies reopen, and business & consumer confidence climbs higher.

Markets are forward-looking and factor in any good or bad news before it even occurs. While a global economic recovery is expected and somewhat priced in by the markets, investors are looking for what lies ahead, beyond the recovery. Current interest rates are the lowest they have ever been. This lever looks to have now largely played out and the next meaningful move in the future will be for policy to normalise and interest rates to rise.

As we have written before, the money supply in an economy is like blood in the body. Blood needs to keep flowing, else you die. Markets are feeling the nervousness (recent volatility) as the likeliness of this extra supply taken away from the economy increases. It is not surprising given the strength in major economies, especially the US, right now.

The Federal Reserve (Fed) has recently suggested withdrawing some liquidity from the markets that it injected after the COVID-19 to stabilise the economy and has also provided projections suggesting increased chances of rate hikes next year. To provide some context, Fed has been putting $120B into the markets via its asset purchases every month as one of its tools to stabilise the economy. 

The Fed has now recognised that the economy no longer needs as much support and so it can begin to reduce the pace of its asset purchases.

The timing and magnitude of this reduction (known as tapering) will be discussed by the Fed in future meetings. We believe that central banks would like to see a well-functioning economy and a sustained recovery before withdrawing their support.

The key message here is that we have started to see a gradual trend toward tightening by some central banks. As mentioned in the last article, strong inflation numbers have been refuted by central banks and the market as transitory. This is supported by meaningful data, and we concur with this view. As economies continue to grow out of the pandemic and inflation numbers remain elevated for longer, fading policy support and higher interest rates will soon appear on the horizon. 

Corporate earnings have been very strong; markets were reflecting these earnings before they were even materialised. A rise in both inflation and interest rate expectations was the key reason for the rotation from growth to value during the last few months. This trend has been reversed recently, following reassurance from the Fed on containing inflation. We have seen the momentum swinging between growth and value stocks in the past few months. We believe choosing one out of the two can limit investment opportunities – when one door closes, another usually opens. Hence, we remain balanced in portfolio construction.

As the global economy moves from recovery to expansion, forward earnings momentum remains very supportive for markets, and analysts have revised expected earnings higher for the next two years. Yet we remain neutral on equities – our tactical approach suggests that markets may struggle to find the next piece of good news when a successful vaccine rollout is now likely discounted by markets along with the delivery of further fiscal support in the US.

We continue to maintain sufficient liquidity in portfolios via government bonds, cash, and cash equivalents to quickly deploy capital when opportunities arise, as we have done repeatedly in the past. Please get in touch for more insights.