INVESTMENT LINE: OUR CURRENT THINKING ON MARKETS - OCTOBER 2021

It is fair to say that it is getting increasingly difficult to dismiss inflation concerns. True, some of the factors may be transitory in nature but it is in truth very difficult to assess how long-lasting many of these factors will be. We have seen US CPI in September hit 5.4%, warnings from the Bank of England’s new Chief Economist that the duration and magnitude of this “transitory inflation” might be greater than expected, and inflation break-even rates in Europe rising sharply. The well-publicised supply side issues are driving much of this pressure of course, but it will become increasingly difficult for the central banks to remain inactive if the data trends persist or strengthen. Indeed, in the UK, a rate rise is now expected to come as early as next month with further action possible in December. If they do move on rates, even to a modest degree, the effects are somewhat uncertain. Suppressing demand would of course help to make supply constraints less of an issue, but at the cost of slowing down the global economy significantly – something that markets are unlikely to greet with open arms. In fact, excess demand really is not the issue right now. This does leave the monetary authorities in a very difficult position indeed. The great fear of course is stagflation where we see meaningful inflation and a slowdown in the economy, perhaps even a contraction if rate movements induce this. This is not our base case but certainly the press is saturated with commentary making comparisons with the 1970s (not a wonderful decade for most investors!). Whatever responses we see, some areas of fixed income do look very vulnerable, and this has led us to continue to reduce allocations. These changes are continuing our direction of travel, but the backdrop is not clear enough to justify completely wholesale change at the current time, though Treasuries are seeing a meaningful reduction for many. If the inflationary thesis materialises (or looks convincingly like doing so) we will not hesitate to take even more substantial action in addition to holding existing assets which provide portfolio protection.

Japan appears to be in a more uncertain position than it was. We have a new Prime Minister in the form of Fumio Kishida and a general election on October 31. It is fair to say that the start of his premiership has been somewhat uncertain. Mr Kishida’s approval rating is hovering around the 50% mark which might sound more than decent but is lower than that of his predecessors when they came to office and many commentators believe he will have a limited period of time in which to enact any reforms. On that note, he has signalled a likely turning away from Abenomics which he believes has been largely unsuccessful. Although corporate earnings and employment have moved in the right direction, he is keen to achieve a greater distribution of economic benefits across society which should in turn help with boosting consumption. It is unclear how this will go down with markets – Abenomics played a key role in reinstating the appeal of Japan in the eyes of investors – and only time will tell. He has already had to backtrack on plans to increase capital gains tax so is already on slightly shaky ground. However, the impact of politics on equity markets is often exaggerated and the high quality nature of many Japanese companies combined with attractive valuations (certainly compared to many peers) means involvement here remains sensible.

Investment Line is written and edited by members of the Mattioli Woods Group investment committee and is for information purposes. It is not intended to be an invitation to buy, or act upon the comments made, and all/any investment decisions should be taken with advice, given appropriate knowledge of the investor’s circumstances. The value of investments and the income from them can go down as well as up, and you may not get back the amount invested. Past performance is not a guide to future returns.

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