Inflation, Growth and Removing the Punch Bowl
Mark Richards, Strategist, Multi-Asset team, discusses economic fundamentals, market sentiment and the debates around inflation and tapering of central bank support.
Policy and economic fundamentals continue to support risk-taking in financial markets. Sentiment in the last month or so has become less of a drag on our risk appetite as there has been a moderation in bullishness across the market. Market valuations are full, but we think they can stay that way for some time.
We know that growth momentum will peak in the next two months or so. But what will the decline be, and how does the market react? We think the economy will go from the current very elevated levels of growth to something around trend in six months’ time. We do not expect growth rolling over to alarm markets. This is because of the level of excess savings in the economy, and inventory levels are very, very low in most sectors. That means the production cycle can carry on being robust for the next three to six months, if not longer.
Inflation remains the key debate, but we do not expect there will be enough evidence for either camp to declare victory until the end of the year. Our view is that markets still have to price in the risk of sustainably above-target inflation. We are looking at the labour market for signs of durable inflation but because the US is only partially reopened and unemployment insurance payments are still going out, it is hard to get an accurate read on wage inflation. There are tentative signs however: the broadest measure of labour costs, the US employment cost index, in Q1 rose at the fastest quarterly pace in more than 14 years and wage pressure within low-skilled parts of the economy are somewhat elevated given the stage of the business cycle.
On policy, the Federal Reserve (Fed) is committed to its switch to an outcome-based rather than an outlook-based approach, but will also be aware that the large degree of fiscal stimulus can de-anchor inflation expectations. Tapering of central bank support for the economy, or removing the punch bowl, is inevitable, and we are starting to see evidence of a very subtle hawkish shift from key Fed members. The process will take several months, with the Fed keen to avoid any sudden shift higher in bond yields and tightening of financial conditions.
Climate change at the top of the agenda
Rhys Petheram, Head of Environmental Solutions, gives his reaction to recent regulatory and governmental changes to address climate change.
There have been important developments recently on climate change. A key milestone was a report issued on 18 May by the International Energy Agency (IEA), detailing ‘an unprecedented transformation of how energy is produced’ to achieve net zero emissions by 2050. The report said that annual energy investment would need to surge to US$5 trillion by 2030, up from US$2 trillion today, to increase clean energy and energy efficiency. Recognising the urgency of the need for change, the IEA said that to meet the scenario there should be no investment in new fossil fuel supply projects.
On 20 May, President Joe Biden signed a wide-ranging executive order to improve disclosure of climate-related financial risk. Treasury Secretary Janet Yellen will report on how to reduce risks to financial stability. Suppliers to the US government will have to disclose publicly their greenhouse gas emissions and set science-based reduction targets.
In the UK, Andrew Hauser, executive director for markets at the Bank of England, made a speech outlining a framework for greening the Bank’s corporate bond purchase scheme. This is in line with the change in the mandate of the Bank of England to include the transition to net zero emissions, which was announced by chancellor Rishi Sunak in his March budget statement. The Bank of England’s £20 billion corporate bond portfolio, which until now has been constructed on a market neutral basis, will be tilted toward organisations with credible transition plans. If bond issuers cannot demonstrate credible transition plans, they will be excluded from the Bank’s buying list. Although £20 billion is not all that significant in the context of fixed income markets, I expect the Bank of England’s leadership and signalling to have an effect on UK institutional bondholders.
This could also help bring about a welcome dispersion in credit markets, where compression of spreads, and a lack of differentiation in yields between different grades of credit, has been a problem. Companies considering transitioning rapidly may be encouraged to do so by a supportive policy environment for their bonds. We expect companies whose products and services address environmental challenges to benefit as enablers of the transition that is increasingly sought after.
UK’s IPO market roars back to life
Matt Cable, Fund Manager, UK Growth, compares this year’s UK IPO and capital raising activity to last year’s, and explains how this activity tends to move in cycles.
IPOs and capital raisings are an important part of my investment process, and they are something a large, experienced team like ours can really benefit from. These transactions often come with a degree of mispricing as they are fast-paced and there is an imbalance in supply and demand; there are many behavioural elements that come into play, too. This gives us the opportunity to apply our fundamental research skills, as we aim to identify the best deals.
Of course, IPOs and capital raisings move in cycles – and these cycles can be helpful from a portfolio management perspective. In periods of market weakness, you are more likely to find companies raising capital, which can provide attractively priced transactions; when valuations are looking more stretched, we often see greater IPO activity, which can instead provide new potential investment opportunities.
Unsurprisingly, 2020 was not a vintage year for IPOs – the first 11 months of the year were the weakest in at least a decade, and 2019 was not much stronger. However, December marked the start of the recovery of the UK IPO market, and year to date the pipeline has been very strong. To give an idea of the scale of the recovery, from January to April 2021 there were 27 full IPOs, compared to just 8 in January to April 2020 and 10 in the same period in 2019.
Conversely, there was a lot of capital raising last year, as many companies looked to shore up their balance sheets to ride out the pandemic. In 2020, we saw around 250 deals of £5m or more, worth approximately £31bn, compared to an IPO market of just £8bn, and many of these transactions delivered attractive returns. Some of the best capital raising deals were from companies that were raising money for Covid-related reasons e.g., those that were developing potential treatments or tests.
While we are seeing fewer rescue-type deals this year, there are still many companies looking to raise capital. Coupled with a roaring IPO market, right now UK investors like us have access to a wide range of exciting potential opportunities.
The value of active minds: independent thinking
A key feature of Jupiter’s investment approach is that we eschew the adoption of a house view, instead preferring to allow our specialist fund managers to formulate their own opinions on their asset class. As a result, it should be noted that any views expressed – including on matters relating to environmental, social and governance considerations – are those of the author(s), and may differ from views held by other Jupiter investment professionals.
Market and exchange rate movements can cause the value of an investment to fall as well as rise, and you may get back less than originally invested. The views expressed are those of the individuals mentioned at the time of writing, are not necessarily those of Jupiter as a whole, and may be subject to change. This is particularly true during periods of rapidly changing market circumstances.