Despite the persistence of COVID, major share markets delivered strong returns through to the end of 2021. The global economy clearly continues to recover, but the pace is easing. While the outlook remains positive, challenges remain, particularly the emergence of new COVID variants and the sharp rise in inflation.
Assessing the key challenges
COVID variants
We ended 2021 looking at high vaccination rates and the re-opening of economies in full swing. Many of us felt we would be ‘living with the virus’ by now. However, Omicron has given us some food for thought, demonstrating that living with the virus may mean future bouts of lockdowns with the emergence of new variants.
Clearly we still have a way to go, and we shouldn’t downplay the impacts of Omicron, but our understanding of COVID and how to manage it improves each day and we should expect COVID to, eventually, become endemic, rather than the threat it currently poses. Meanwhile, Omicron has proven to be disruptive to supply chains as we’ve seen in empty supermarket shelves and the help wanted signs in store windows.
While society continues to adjust to Omicron, markets are now looking forward to a world which has learnt to ‘live with’ COVID, with growth assets continuing to benefit from this, despite the more recent volatility.
The holiday from inflation is over
A further challenge in our future post pandemic world, is the re-emergence of inflation, a risk that hasn’t grabbed headlines for many years, but it looks like the long holiday may be over. The combination of burst of pent-up demand and spending as many countries have come out of lockdowns, and disruptions to supply chains for everything from microchips to cars has meant many goods are harder to find, sending prices spiralling higher.
Both the US economy and inflation have been building up a head of steam with recent data likely ending arguments against the case for higher interest rates. The US economy grew by 5.7% in 2021, the fastest pace since 1984. This has been a strong comeback for the American economic engine despite the pandemic.
A lot of good news was packed into the 5.7% figure with unemployment falling to pre-pandemic levels, rising wages, businesses investing strongly and a lift in consumer spending. However, the bad news is that inflation, as measured by the US Consumer Price Index, was even higher, reaching 7% in December, the biggest number in 40 years.
Inflation isn’t a US-only issue though, with inflation in many countries now higher than before the pandemic. Most central banks have inflation targets, usually in the 2-3% range, and it’s going to take some effort to pull back inflationary trends.
We’ve been concerned about inflation for some time and that’s why we’ve been moving away from fixed interest assets and allocating funds towards ‘alternative assets’ with different return patterns to traditional assets. We also believe our alternative assets will react differently to a rising interest rate cycle when compared to fixed income and shares.
What may be ahead?
The challenges of Omicron and inflation have contributed to the market jitters we have seen in early 2022, but we shouldn’t forget there was an incredible surge in markets following the pandemic-driven recession. The more recent market correction was focussed across heavily leveraged assets (those businesses which had borrowed on the basis of zero and negative rates, now fearing these ultra-low rates are going to be steadily unwound) and should support returns going forward.
We think we’re now returning to more constructive share market valuations, reflecting the progress that’s being made in removing central bank ‘emergency’ pandemic policy settings. It should always have been expected that the extreme policy support would eventually be removed.
So, while the high ‘pandemic bounce back’, double-digit returns aren’t likely to continue, we expect we will likely see solid but more modest returns as the next phase of the recovery matures. All up, it’s still a positive market outlook story.
