Monday Digest

Posted 29 March 2021

Overview: Edging closer towards a post-pandemic world  
Last week was another one of markets feeling on edge without going anywhere. Investors seem to have caught a bit of worry about the passage of growth, oddly just as the recent headwind of rising bond yields abated. Perhaps we can attribute the bubbling up of political tensions as the cause of the recent market torpor, replacing expectations of a very fast and unprecedented recovery growth spurt with just a fast and substantial one.  

In Europe, pandemic politics continues to dominate, with European Union (EU) leaders still embroiled in skirmishes over the consequences of its ineffective vaccine distribution. Germany’s Angela Merkel faced her own crisis, after a backlash from lockdown-fatigued German citizens, who simply said “Nein” to her new Easter restrictions. One might think this would be a bad thing for markets, but private freedoms are what makes markets function. The prospect of regaining those freedoms is why business and consumer confidence readings this week were especially robust in the EU, stronger than economists were anticipating and at levels we seldom see. 

So, despite the latest pandemic updates failing to provide the short-term relief many of us were hoping for, we are collectively starting to move towards a post-pandemic perspective. Given the lack of short-term certainty, market activity cannot be expected to run in a straight line, even as economic activity improves. But increasingly, the topics that preoccupied the pre-COVID world – such as the risks arising from geopolitical tensions – have become focal points once again. That may provide an element of comfort for a world that has grown so weary of talking about COVID, but it also underlines the fact that economic opportunities and challenges far bigger than the pandemic (such as climate change) are still waiting to be addressed. 

Europe PMIs show opportunity for improvement  
Positive stories about Europe are thin on the ground at the moment. With a sluggish vaccine rollout and a renewed rapid spread of infections across the continent, restrictions look set to remain in place. This will seriously hamper certain economic activity, and European investors are looking at the future upside potential of US equities with some envy. Some good news, then, is long overdue.  

Fortunately, the latest purchasing managers indices (PMIs) data shows that the slump in Europe is not quite as bad as feared. Manufacturing in France and Germany both exceeded economist expectations, as did the UK, and overall, the Eurozone posted a 62.4 figure for manufacturing against a predicted 57.6. Unsurprisingly, for the services sector – arguably the biggest casualty of government-mandated social distancing – the outlook is less positive. Nevertheless, the services sector across Europe still beat expectations, with France contracting less than predicted, and Germany posting a (slightly) expansionary 50.8. It does now seem service providers are more able to deal with lockdown measures, and some even becoming hopeful about potential easing of COVID restrictions.  

A brighter outlook is something investors could certainly do with. European markets have reacted negatively to rising virus cases and the slow vaccine rollout, which appears to be the key factor in holding back EU businesses. A summer lockdown could be a serious setback for the hospitality-heavy economies of Greece, Spain and Italy. However, the current pessimism could be exactly the reason to be more positive about European assets. Investors are not just hopeful about a strong recovery later this year, they are expectant – with a big rebound already priced in, particularly in the US. European equities are one of the few asset groups for which this recovery is not already fully discounted. European businesses have plenty of catching up to do, but that leaves their share prices with much more room to rebound than US rivals.  

One of the biggest concerns for markets currently is when and how the US Federal Reserve (Fed) will have to start tightening monetary policy. But this concern is entirely absent in the Eurozone for good reason – no-one is in any doubt that Europe still needs extreme monetary easing to continue. This ultimately stems from weakness in Europe’s economy, but it could nonetheless turn into a positive. As the world moves away from easing, and markets get the recovery they are expecting, Europe could be the one market still powering forward just to catch up. Ultimately, that could help investors further down the line. 

Geopolitics back on the radar as diplomacy runs aground  
As we enter spring, the world thankfully looks a little brighter. The vaccine rollout is well underway in the UK and US, and is having palpable effects on the outlook for the second half of this year – despite disruptions on the continent, mutation scare stories and ‘vaccine nationalism’ showing up around the world. For investors, despite the caveats, there has also been a notable improvement in near-term economic expectations. Nowhere is this truer than the US, where easing conditions, an accommodative Fed and a blast of fiscal stimulus have set the stage for a full-speed recovery. But this strength should fortunately filter out to the global economy and, even without the US spillover factor, there is a sense that – for  the rest of the world – the harsh winter is also behind us. 

Perhaps more importantly for the medium-term investment horizon, broader geopolitical themes are moving back into focus. The hope was that relationships between China and the US would improve with an intense ‘charm offensive’ under the Biden era. But so far, the new administration’s interactions have been short on charm, with Biden preferring to go on the offensive. The relationship between the world’s two largest economies has been strained for years, with Trump’s trade war provoking tariffs on both sides. Delegations from both nations met in Alaska to commence the new relationship, but the resulting shouting match was hardly a ‘diplomatic’ start. 

Beyond the rhetoric, the most notable US action has been to corral allies (the EU, UK and Canada) to impose sanctions on senior Chinese officials over the treatment of Uighur Muslims in the north-western autonomous province of Xinjang. While sanctions are a long-used political tool, and have been in place against Russia for several years, this is a new feature in the West’s relationship with China. Biden has also moved forward with Trump’s threat to delist Chinese equities from the US stock market – a decision many investors expected him to reverse. These moves have already had an effect on equity markets, with Chinese stocks declining after the delisting rumours spread (as well as a domestic Chinese clampdown on its own tech companies) and the Renminbi weakening against the dollar. While we expected Biden to keep up policy pressure on China, we expected a more tactful tone than his predecessor. But, so far, capital markets appear to have mostly shrugged off these tensions.  

At Tatton, we always exercise caution when linking geopolitics to investment. Our experience is that being overly focused on specific risk scenarios can lead to overestimating both their likelihood and their negative impacts. We maintain the belief that investments grow best under applied risk management, rather than risk (and therefore return) avoidance. Another aspect for investors to remember is that risks are all about ‘unknowns’. Individual investors can never have all the information, and there are always areas where some information is less reliable than others. Companies may try to present the best interpretation of their outlook, but strict regulation prevents them from skewing this interpretation too much. Politicians and diplomats are not subjected to the same types of audit. So, in general, we look to monitor political risks while being moderate in their application to investment strategy. At the moment, geopolitical concerns are not enough to derail economic positivity. In other words, risks are not the same as themes. But they are certainly narratives we will continue to watch as the wider world returns to a more normal state. 

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