Getting the economy back up to speed after two halves in 2021
As we close the final chapter of 2021, it’s important to recognize how far we’ve come since last year. Armed with vaccines and viable Covid-19 treatments, the global economy is learning to live with the pandemic, just as investors are learning to invest with it.
We can sum up the year as a tale of two halves. The end of 2020 saw the first Covid-19 vaccines announced as economists began to predict the shape of the recovery. The first half of the year was therefore entirely devoted to growth, with record quarterly figures. The UK experienced a flash recovery in the second quarter, where the recovery was over 20% from the previous year. Corporate profits reflected this with record numbers.
The second half, however, saw the world quickly enter a “mid-cycle” slowdown despite the end of UK holidays and a series of improved unemployment benefits in the US. Rising prices due to supply disruptions weighed on the level of consumption growth observed in the first half of the year. That said, productivity gains, a healthy pipeline of budget spending, and climate-focused investments should help post-pandemic growth rates.
Looking to 2022, we believe that the way in which the world’s major central banks are withdrawing emergency measures is essential to sustaining the momentum of the recovery; it needs to be careful, measured and data dependent. With the removal of government support, this should lead to a more self-sustaining model with a good chance of success if combined with a return in demand in the sectors most affected by the pandemic.
However, disruptions in supply chains, divergences between companies that have benefited from the pandemic and those that have suffered, the same for developed markets as emerging markets, and searing asset valuations in some areas. must be resolved if we are to successfully revive the economy. at cruising speed.
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We expect capital spending to be favorable as productivity gains and low financing costs encourage investment. Replenishing inventory will keep final demand alive, and activating pent-up demand will support consumption.
While inflation remains high, the extraordinary nature of the Covid-19 recession has affected supply and demand in a way that makes it very difficult to separate temporary inflationary forces from more persistent inflationary forces. Overall, we believe the drivers of the price increases are short term. We predict that prices will not continue to rise as sharply as they were in 2021, but neither will they return to pre-pandemic lows, which means this should slow down but not go away. Over the past decade, asset prices have become a more important determinant of economic growth compared to consumer prices. It is therefore crucial that policymakers think about the impacts of financial markets when they begin to withdraw monetary and fiscal support.
So where does that leave us when it comes to positioning? We remain bullish on equities as an asset class as they hedge against inflation and appear to have good value relative to cash and bonds. Post-pandemic spending in energy transition technologies, digitization, media and advertising, biotechnology and advanced healthcare positions tech and healthcare companies as likely to overtake the economy.
Energy transition technologies will benefit from the global zero carbon emissions targets. “The electrification of everything” has started and new technologies are meeting our growing energy needs and reducing dependence on fossil fuels. In addition to technology and healthcare, we also favor financial companies as they provide portfolio hedge against potentially higher interest rates and a tightening liquidity environment. From a regional perspective, this preference for defensive growth favors US and Swiss equities, which are teeming with high-quality, well-managed companies.
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As we move into the stage where central banks consider tightening monetary policy, fixed income as an asset class has been less effective in dampening portfolio volatility. In real terms, the cost of additional protection against the next recession by buying 10-year US Treasuries or UK gilts is around 1% and 3% per annum respectively. Within high yield credit and emerging market debt, we believe active management and selectivity are essential. When central banks withdraw liquidity and governments end their support for the pandemic, “zombie” companies could potentially prove to be worrisome in the race for yield.
Finally, as the world grapples with Omicron, we remain attentive to how central banks respond to a potential economic downturn, just as monetary policies begin to normalize. Ultimately, we see strategic asset allocation, active management and disciplined diversification as the key to navigating this uncertain outlook.
Stuart Paterson is Executive Director of Julius Baer International Limited