After their small dip in January, global equity markets continued to climb higher in February. There is growing confidence that vaccines will end economic lock downs and there will be a return to trend growth in many countries. Traditional value stocks, indebted stocks and smaller capitalisation companies performed particularly well. Some of this move is due to relief that economic conditions are expected to improve. Much of this move can be also be accounted for by changing expectations of monetary policy. A prolonged rise in inflation would force central banks to raise interest rates.
The great inflation debate is on-going, and the truth is that no-one knows for sure what will happen. If there was one economic variable that the Ashburton Investment team would like to know for long term investment it would be the inflation outlook.
On the one hand with close to a quarter of all US dollars in existence created by the Federal Reserve in just the last year, some economists confidently predict inflation. On the other hand, some economists argue that both technological advancements and the massive reduction in money circulation have huge deflationary effects. As President Truman once reportedly said “Bring me the one-handed economist” Only very few have predicted hyperinflation given that confidence in central banks appears to be solid.
A general steepening on the yield curve saw some rotation from traditional growth towards traditional value stocks during the month. For this rotation to be sustained we believe that investors need to factor in a rise in interest rates. This could come as a result of increased inflation which would force central banks to raise rates.
There are a few diametrically opposed forces acting on inflation. On one side are the printing presses of the central banks, a general increase in household savings and supply shocks. On the other, are a decrease in the frequency money changes hands, increased consumer caution, spare capacity in both labour markets and production facilities and a rise in technology. On balance, we do not see a dramatic rise of inflation over the next few months and believe that central banks will be relatively slow in their tapering efforts.
Our views expressed on the market as at the end of February/beginning of March 2021.