Monday digest
Posted 15 March 2021
Overview: Markets continue to recalibrate
Last week was another choppy one for global stock markets, although for equities there was more up than down across the board, and bonds yields stopped their upwards trend, at least for now. The general upward trend notwithstanding, there was notable rotation and counter-rotation between different market segments. Clearly markets are still undergoing a recalibration phase. Rising bond yields (on the back of a vastly improved near-term economic outlook) mean stock markets must learn to stand on their own feet again, instead of relying on being the only investment show in town. Valuation metrics are beginning to matter again and, just as the pandemic divided companies into winners and losers, so will the catch-up recovery that lies ahead.
In Europe, it is worth noting that the slow roll-out of mass vaccinations is ratcheting up tensions. Last year, Europe’s leaders gained plenty of praise after they worked together to raise vast amounts of fiscal stimulus money jointly. But it turns out that wishing to work together is not the same as actually getting things done at speed. Therefore, it remains to be seen whether the European Union’s recovery fund will lag behind US President Joe Biden’s infrastructure rebuilding plans. While the US’s progress on stimulus captured most of the headlines last week, we should keep in mind that European nations are approaching elections, and politicians cannot afford for their countries to continue to lag behind for much longer. We hope that this urge by politicians to get things moving will manifest itself on constructive industrial and infrastructure policy action, instead of the current painful finger pointing.
Biden brings out the (short-term) bazooka
Fiscal stimulus always excites investors, and nowhere has been more exciting on the fiscal front this year than the US. The Biden administration hopes its $1.9 trillion recovery plan will kickstart the American recovery in earnest. Given the size and importance of the US economy, markets are also hopeful that US activity will have a significant effect globally, generating demand to power the world economy forward this year and beyond.
Markets have become excited and concerned in equal measure about the inflationary impacts that America’s fiscal drive could have, but ultimately, stop-gap support is unlikely to send price levels skyward sustainably. The real excitement on the fiscal front comes from the long-term changes to spending, with promises of productive public investment in vital infrastructure. There was not much mention of long-term measures in Biden’s relief bill of last week. The plans do increase short-term government borrowing, but there is no structural widening of the budget deficit, with fiscal expenditure expected to fall dramatically next year and beyond.
None of this is to say that the rescue plan is insignificant. Support is undoubtedly vital for millions of Americans, and the knock-on effect it could have on confidence and spending habits should not be underestimated. Biden’s plans are bridging the COVID gap, but legislators have a fairly generous interpretation of what that means. That is important for inflation expectations, since stimulus is likely to be amplified once activity returns to normal levels.
Ultimately, however, the plan will not provide the ‘supercharge’ for long-term growth that some might be expecting. Fortunately, the President does have a plan for that too. Biden’s plans on infrastructure and tax reform are likely to have a much longer-lasting impact than his short-term support. This seems to be the Democrats’ hope: Support those who need it and build back confidence with emergency spending, then invest in a productive post-pandemic future afterwards. The political will to make structural fiscal changes is there; it just has not quite been delivered on with this plan. Investors still have much to get excited about when it comes to US fiscal policy. The rapid rollout of vaccines, combined with generous enough support, should mean that growth is ready to return in force – to the benefit of the global economy. We just still need to look out for more structural changes.
Why Chinese policymakers are letting stimulus fizzle out
With China now the world’s largest economy in terms of purchasing power parity, its recently published Five Year Plan (the Chinese Communist Party’s 14th such plan), setting out growth and development targets until the middle of the decade, was keenly anticipated. Past plans have included explicit pledges to reach designated GDP growth numbers – such as the “above 6.5%” level set from 2016-2020. For the most part, those previous targets have been dutifully met (assuming one believes the official Chinese growth statistics). Unsurprisingly, COVID spoilt the party. After harsh lockdown measures across China, the government abandoned its longstanding annual growth target for the first time in 30 years. Even so, the +2.3% growth figure recorded last year was still impressive.
This year, the Chinese government expects growth of “above 6%”. But officials declined to set an average target for the 2021-25 period. Growth will instead be kept “within an appropriate range” and new targets set each year depending on economic conditions. A tailing off of China’s intense growth should not be surprising, but this move is nonetheless significant for what it says about the government’s shifting priorities. The Party appears focused on controlling future risks rather than stimulating the current economy. This ‘controlling risks’ approach is apparent in other areas too. Chinese authorities cut short the Ant initial public offering last year, to make sure the company had a financial holdings framework for its banking and insurance business. Tencent is now under similar regulatory scrutiny over its fintech activities, which is perhaps also confirmation that Chinese authorities have much less qualm to take on the tech mega caps than Western counterparts.
Containing risks now is likely to be a long-term benefit, both for the Chinese economy and international investors. Ultimately, China’s financial infrastructure is too weak to support an economy of its size overall, and improving it will clearly bring benefits. But for now, policy tightening means we should not expect extraordinary economic strength domestically, or for Chinese demand to reinvigorate the global economy as it has in the recent past. Even though underwhelming stimulus from China is certainly an overall negative for global growth, this does not necessarily mean we should be pessimistic about the global economy. For one thing, while China practices caution, the US is ready committed to largesse. That probably means a more general benefit for world growth, whereas Chinese growth tends to specifically benefit commodity, machine and luxury good producers.
Second, government stimulus is far from the only thing China has going for it. There is still a significant potential for growth – with estimates of 8-9% this year – and international investors are becoming increasingly keen to buy Chinese assets. Fortunately, the latter is the kind of financial growth the government is more than happy to encourage. Focusing on stability will actually help here, meaning there are still plenty of reasons to be positive. Overall, we suspect a ‘soft landing’ is on the cards, but we should nevertheless be braced for China’s economic growth to be overshadowed by the rest of the world for the rest of 2021 at least. Stability is a key facet of China’s five-year plan, but it may only see the benefits in the period beyond that.