News from Tatton Investment Management: No tantrum over this taper

5 November 2021

October’s positivity across global stock markets spilled over into the first week of November. That is with the exception of China, which appears to be increasingly isolating itself from the rest of the world. Not only was its leader very notably absent from the COP26 climate summit in Glasgow, but it is also choosing to let international bondholders bear the brunt of the ongoing financial woes of its property developers. No wonder then, that Chinese stocks have fallen thoroughly out of favour with investors this year.

Judging by what the UK media reported this week, investors should have been glued to the capital markets forums at COP26. While there were plenty of leaders from the biggest global investment companies present, it was once again the deliberations of central banks that captured the attention of investors. 

While even better than expected corporate earnings reports have lifted the mood over the past week, there had been a lingering concern that central banks were about to make their first economic policy mistake in their efforts to manage the pandemic period. Faced with more persistent than anticipated inflationary pressures, it was feared that central bankers would blink and break from their stated course of keeping rates and monetary conditions very loose for longer. In particular, the Bank of England (BoE) had signalled since the summer that it was likely to raise rates to prevent inflationary tendencies taking hold. In the US, the Federal Reserve (Fed) had similarly signalled that it would start to reduce monthly liquidity injections by tapering them back down to zero by the summer of next year.

Given the market turmoil the mere mention of such tapering caused back in 2013, markets had been sufficiently nervous to cause movements in the bond markets that suggested a souring of the previously positive medium-term growth outlook (as we reported in October).

As it happened, the Fed did what it had signposted while it was the BoE that blinked, albeit in the other direction – by surprising markets by keeping rates where they were. It may seem that central banks are no longer acting in a concerted fashion, but that is not how it was perceived by the markets. Instead of a renewed taper tantrum, markets remained very calm and indeed took the actions of both central banks (and accompanying language) as confirmation of the previously more positive growth outlook. This manifested itself in rising yields in the longer maturity spectrum of the bond markets, indicating that markets no longer saw the central banks making an error.

This may appear more obvious in the case of the BoE than the Fed, given it held off from any form of tightening, whereas the Fed did not. Yet the message of both was convincingly similar: growth is expected to continue while inflation will very much remain on the radar and pressures should ease next year, once pandemic-induced supply shortages are overcome (for a deeper insight, see our separate article ‘Central bank bait-and-switch’).

Over the course of the week, economic data flow was also broadly supportive of this view, with the US posting a more positive than expected additional 531,000 new jobs during October, and with unemployment falling further to 4.6%.

With energy and commodity prices stablising, and in certain cases rolling over, there was a general calming air felt over the week, even though corporate earnings outlooks have recently not had so much positivity for equity investors. With yields having come down, and neither too much nor too little growth raising the spectre of neither overheating nor stagflation, all should be good? Well, almost, if it was not for some consumer sentiment readings also turning over, and the observation that inflation-adjusted yields (real yields) have remained stable throughout all this. 

This tells us there is still enough to get markets worried again, given the historically-elevated valuation levels they are trading at. If real yields begin to rise in reflection of the improving economic outlook, with lower inflation pressures coming from energy, corporate earnings growth will have to crank up – or risk being left behind by the return of the competition of fixed interest bonds. Usually they do in such situations, but we can be certain that markets will fret about it.

On the side of COP26, big investor news appeared to be in the offing, when the alliance of investment managers led by former BoE Governor Mark Carney announced they now represented $130 trillion of assets that would support the transition towards net neutral CO2. You can read our views on the subject, and how it could shape efforts to transition toward a more sustainable – and unified – economy in the article titled: ‘COP26: Good COP, bad COP’. If nothing else, the announcement suggests something more tangible to emerge from the summit than the ‘climate-unfriendly ‘hot air’ that many had feared.

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