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Share prices stumble after just two months of less loose policy from the Fed

Please find below, an update in relation to share prices, received from AJ Bell yesterday – 23/01/2022

Well, that didn’t take long. The Fed began to pump less Quantitative Easing (QE) into the financial system in November and the stock market’s wheels have started to wobble after barely two months of less cheap money, let alone move to withdraw it.

Investors are already starting to ask themselves how much the US Federal Reserve can do to tighten monetary policy before it either puts the brakes on the economy, breaks the stock market or both – and the answer might be not very far at all.

Some of the asset classes, funds and individual stocks which have performed best, attracted the hottest money flows and drawn the biggest headlines have started to flag, or even fall sharply. All are generally toward the riskiest end of the asset class spectrum, where the rewards can be highest, but the risks are too, should something go wrong.

Small caps are wobbling. America’s Russell 2000 index is now trading below where it was twelve months ago, and the UK’s FTSE Small Cap benchmark is losing a little momentum.

Source: Refinitiv data

Meme stocks are taking a pasting. You have to hope that anyone who has held on to GameStopAMC Entertainment and others to thwart the hedge funds who were short-selling these names have not ended up cutting off their own noses to spite their face. Buyers in the very early days may still be in the black, but anyone who piled in late to join the fun or try to make a fast buck could now be deeply in the red.

Source: Refinitiv data

Cryptocurrencies have swooned once more.

Source: Refinitiv data

And the poster child for fans of momentum, tech and potential disruptive winners, the ARK Innovations Exchange-Traded Fund (ETF), continues to sink.

Source: Refinitiv data

It may not be a coincidence that the Fed has started to reduce the amount of monetary stimulus it was pumping into the US economy via Quantitative Easing. It started to cut QE from a run-rate $120 billion a month by $15 billion a month in November and then by $30 billion a month from December.

That should mean the Fed’s $8.8 trillion balance sheet stops growing in March. After that, the central bank may turn to Quantitative Tightening (QT) and start to withdraw stimulus and shrink its balance sheet.

Meanwhile, the markets have started to price in at least four one-quarter percentage point interest rate increases from the US central bank by the end of this year.

Source: CME Fedwatch

Recent precedents for tighter monetary policy (or even simply, less loose, less accommodative policy) are enough to give investors pause for thought:

  • In 2013, financial markets rebelled at the very talk of tighter policy and the so-called Taper Tantrum persuaded the Fed to back off.
  • Between December 2015 and December 2018, under Janet Yellen and then Mr Powell, the Fed raised rates from 0.25% to 2.50%. It also shrank its balance sheet by $700 billion, or some 17%, between 2017 and 2019. But it then stopped as the US economy began to slow and signs of stress began to show in the US interbank funding markets in autumn 2019. As a result, the Fed’s balance sheet had started to grow again several months before the pandemic prompted fresh interest rate cuts and more QE in the spring of 2020.

Source: FRED – St. Louis Federal Reserve database, US Federal Reserve

There are good reasons for such caution. Global debt is so much higher now than it was in 2013 or even 2018, so the economy will be much more sensitive to even minor changes in interest rates.

More specifically for share prices and company valuations, tighter monetary policy – at a time when indebted Governments are throttling back on their fiscal stimulus programmes and looking for fresh sources of income from tax or social levies – has four possible implications:

  • Higher interest rates may mean an economic slowdown, again because there is so much more debt in the system. As the old saying goes, economic upturns don’t die of old age, they are murdered in their beds by the US Federal Reserve. In addition, consumers’ ability to consume will be crimped if inflation outstrips wage growth and their incomes start to stagnate or fall in real terms.
  • Higher rates reflect inflation, and faster (nominal) GDP means investors do not have to pay a premium for long-term future growth (for secular growth names like technology and biotechnology) when potentially faster, near-term cyclical growth (‘value’) can be bought for much lower multiples (even if it comes from oils, miners, banks).
  • Inflation can eat away at corporate margins and profits. Right now, they stand both at pretty much record highs, as do valuations, at least in the USA, based on ratios such as market cap-to-GDP and Professor Robert Shiller’s cyclically-adjusted price-to-earnings (CAPE) ratio. If earnings start falling, valuations could do so, too, if confidence wobbles. Instead of the double-whammy that provides gearing to the upside, as investors pay higher multiples for higher earnings to give ever-higher share prices, markets see the opposite: earnings fall, investors pay lower multiples for lower earnings and share prices fall faster.
  • Higher interest rates mean analysts and investors deploy an increased discount rate in their discounted cash flow models to calculate the net present value (NPV) of future cash flows from long-term growth stocks. A higher discount rate means lower NPV. A Lower NPV means a lower theoretical value of the equity and that means a lower share price.

All four are clearly worrying previously rampant financial markets but that in theory should not be the concern of the US Federal Reserve, or indeed any central bank. Their job is to keep inflation on the straight and narrow, to ensure it does not destroy wealth and prosperity and imbalance the economy.

But a decade and more of zero interest rates and QE – unintentionally or intentionally (judging by a string of speeches from former Fed chair Ben S. Bernanke dating back to at least 2003) – have persuaded or forced investors to take ever-increasing amounts of risk to get a return on their money.

Central banks are presumably concerned that having tried to create a wealth effect by stoking asset prices, the opposite effect could kick now in, hitting confidence and consumers’ ability and willingness to spend.

If inflation really does prove to be sticky, or even keep going higher, central banks may therefore be stuck between a rock and a hard place. They will want to control inflation on one side but their ability to jack up interest rates and withdraw QE may be constrained by record debts and concerns about the economy, employment (and financial markets’ stability) on the other.

Please continue to check back for a range of blog content from us and from some of the world’s leading fund management houses.

David Purcell

24th January 2022

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European political and regulatory outlook 2022

Please see below, a European political and regulatory outlook from Invesco – received late yesterday afternoon – 13/01/2022

Key takeaways

Covid-19 continued to present a threat to European economies in 2021 and revealed deep fissures in the political landscape. The pandemic didn’t just leave its mark on the political scene but also in the regulatory sphere — a trend that will continue in 2022.

We expect key political drivers to include the recent German election and the upcoming French presidential vote, which comes amid concerns over Russia and China’s influence. The cost of the green transition, inflation and Brexit will also be major themes this year.

On the regulatory side, policymakers will make further refinements to ESG frameworks; roll out initiatives to enhance retail investor participation; increase their focus on financial stability; and turn their attention to the supervision of digital financial services.

Covid-19 continued to present a threat to European economies in 2021 and revealed deep fissures in the political landscape. The pandemic isn’t just leaving its mark on the political scene but also in the regulatory sphere, where regulators are grappling with the lessons to be learned from the market volatility and so-called ‘dash for cash’ at the start of the pandemic in March 2020.

We turn our gaze to 2022 and seek to highlight what we see as the major political and regulatory risks on the horizon.

Section 1: Political outlook

  1. Our analysis identifies 8 key themes that will influence the political landscape:
  2. The outcomes of European elections in France (this year) and Germany (in 2021) are likely to colour approaches to further EU integration, opening the field for a triumvirate with Italy.
  3. Battles over the rule of law in Hungary and Poland will raise questions about the nature of the EU and its members, as well as fears regarding Russia’s intentions.
  4. The EU’s strategic autonomy to act against a backdrop of increasing global polarisation between the US and China will influence trade, defence and economic thinking.
  5. Reviewing the fiscal rules that govern the eurozone will shape the EU’s ability to invest in the green and digital transformations.
  6. Implementing the UK and EU’s climate commitments will finally turn promises into action, with fights expected on the pace, and who should bear the cost, of the transition.
  7. With above-target inflation likely to persist in both the euro area and the UK, the cost of living will likely re-emerge as a political battleground.
  8. Further antagonism between the UK and the EU over the implementation of Brexit will continue to weaken incentives to build cooperation in other areas, such as financial services.
  9. Opposition to UK planning reforms could undermine Boris Johnson’s election pledge to ‘level-up’ the UK outside London and the South East.

 European leadership and integration

France and Germany are the traditional motors of European integration, and it’s often difficult to get anything done in Europe without the endorsement of these two states. It is therefore significant that Germany has a new government that will start to reach cruising speed in 2022 while France will head to the polls in April 2022.

In Germany, the so-called “traffic light” coalition made up of the Socialists, Liberals and Greens took office in December 2021. This was a watershed moment that brought to a close the stability and statesmanship that Angela Merkel brought to Germany and to Europe more widely.

In France, President Macron will face voters in April 2022, along with a fragmented field of candidates. While current polls indicate that Macron remains the favourite to win the election, the campaign has been marked by increasing populist sentiment, particularly from the right and far-right that are hoping to capitalise on anti-immigrant attitudes.

The outcomes and consequences of these elections will have a strong impact on what can get done in Europe in 2022, as well as the years to come. Although the new German government is likely to be closer to France in terms of European integration, the ability of a new and untested coalition to bring key European partners with them is likely to be weaker than under Merkel. France may have less appetite for grand integration projects for fear of it triggering heightened populist sentiment at home.

The Franco-German axis may be weakened, but it may also to include the Italians as Mario Draghi brings stability and statesmanship that has been absent in Italy for some time and gives it a strong voice in European matters. The recent Quirinale Treaty between France and Italy could be a first step in building a strong triumvirate at European level that would be pro-European integration.

 Threat from the East

While not new, the battle over the rule of law in the Eastern bloc, and in particular in Poland and Hungary is likely to continue simmering in 2022. For many member states and the European Parliament, the values on which the EU is built are at stake due to the issues presented in Poland and Hungary. These challenge the EU’s ability to advocate about democratic values abroad if they can’t keep their own members from backsliding.

For Poland and Hungary, the issue is as much about domestic politics as it is about the financial incentives on offer from the EU, with Poland having threatened to bring the EU decision-making process to a standstill if EU funds are withheld. It’s not only about Poland and Hungary. Czechia, Slovenia and Bulgaria are also at risk of breaches of rule of law.

But there is division within the remaining member states on how to respond. Although the European Parliament is urging the European Commission to invoke the rule of law provisions in the EU budget — which enables the Commission to withhold funding until steps have been taken to address rule of law issues— Germany and others have called instead for dialogue.

The one glimmer of hope on the horizon is that there are elections in Hungary in May 2022 and recent polls indicate that the opposition candidate that aims to unite all opposition parties against Prime Minister Viktor Orban has a realistic prospect of unseating the incumbent. With Prime Minister Andrej Babis of Czechia having also recently lost elections, is the tide turning on populism in the East?

Even if the debate over the rule of law is primarily an internal issue within the EU, it also has geopolitical dimensions given the increasing assertiveness of Russia and pressures on the EU’s Eastern border from Belarus. As a result, some countries such as Germany have been wary of a direct confrontation with wayward Eastern states for fear of alienating those countries and driving them into the arms of Russia.

 Strategic Autonomy and National Security

The EU’s focus is often internal but increasingly the theme of “strategic autonomy” is discussed within EU circles. In part a response to former US President Donald Trump’s exposure of EU reliance on the US and growing Chinese assertiveness on the world stage, the question of the EU’s place in the world — squeezed in between the US and China, as well as its ability to act independently — continues to be actively discussed.

The EU is increasingly eager to review its dependence on the US for defence and its reliance on the dollar clearing, which has limited the EU’s ability to run an independent foreign policy. The strained relationship with the Trump Administration and the Biden Administration’s recent missteps including the disorderly withdrawal from Afghanistan and the recent AUKUS nuclear submarine deal have raised questions about EU-US relations within European policy circles. In particular, the EU fears being forced to choose between the US and China, which it is loath to do.

The EU’s relationship with China is equally complex. It branded China a negotiating partner, economic competitor and systemic rival in 2019 — and the EU continues to struggle to define a clear China strategy. While the commercial imperative remains strong, with China having become Germany’s top trading partner, the stalled investment treaty negotiated at the end of 2020 shows that the economics cannot be fully divorced from the politics, with voices increasingly urging the EU to use its influence to address the human rights issues and other security threats in China. For example, a recent motion by the European Parliament called for the EU to get tougher with China when it comes to human rights violations; spreading disinformation; assessing the origins and spread of Covid-19; and banning companies from 5G and 6G networks that do not fulfil security standards, all while continuing to work together on climate change and other areas of mutual interest.

Concerns regarding the US, China and strategic autonomy are likely to continue to exert a strong influence across several areas, including trade and defence but also economic topics such as the internationalisation of the euro and work on central bank digital currencies where the EU fears falling behind the US and China.

Instinctively closer to the US, the UK is confronting many of the same questions as the EU regarding China – seeking to maintain access to the commercial opportunities of the Chinese market while being increasingly vocal on human rights issues; taking steps to protect its critical infrastructure from Chinese influence; and pursuing a more active role in scrutinising the takeover of British companies in sectors deemed sensitive for national security. The (non-retrospective elements of the) National Security and Investment Act came into force from 4 January 2022, increasing the risk that certain takeovers and mergers could be significantly delayed due to increased government scrutiny.

Reviewing the Stability and Growth Pact

The rule governing the EU and eurozone fiscal policies, known as the Stability and Growth Pact (SGP), was suspended when Covid-19 hit and remains suspended until 2023. However, 2022 is likely to be dominated by debates as to how to re-introduce the rules and whether the SGP needs to be overhauled given the significant budget deficits and debt overhangs that many countries suffer from due to the pandemic.

With the EU average debt-to-GDP ratio above 100%, there is concern that a strict re-introduction of the rules[1], could force a significant number of countries to introduce austerity measures. This would potentially plunge the EU back into recession and prevent member states from undertaking the necessary investments in climate change and digital to reform their economies for the future. There is also concern that the rules have become increasingly complex and hard to monitor adequately. However, a number of the so-called “frugal” member states consider the current rules sufficiently flexible and have limited appetite to reform the framework.

The success, or otherwise, of the Covid Recovery Fund, could also play a role here as many see it as a potential blueprint for a more permanent EU-level fiscal capacity that might serve as a bridge between the current SGP rules and the need to invest in the green and digital transformations across the EU.

The review of the fiscal framework comes at a time when Europe is suffering from high inflation. While the European Central Bank considers current inflation rates transitory and has so far resisted calls from hawks to increase interest rates, it remains to be seen how long this view will prevail, particularly if other central banks start to consider higher inflation is here to stay and start raising rates.

Net Zero and EU Green Deal

If 2021 and COP26 was the year of climate promises, then 2022 is set to be the year of climate delivery. Both the UK and the EU have committed to ambitious carbon reduction targets of 68% and 55% respectively by 2030.

The debate in 2022 will be focused on how we get there. In the EU, the European Commission published in July 2021 a package of proposals known as “Fit for 55”, which will amend a range of EU law, including the Emissions Trading Scheme, the Renewable Energy Directive and the Energy Taxation Directive with the aim of aligning the EU regulatory framework with the EU’s climate targets. However, the cracks are already starting to appear. The EU Taxonomy, which aims to classify which activities are “green” has already run into the buffers as various members seek to protect their own industries — such as France on nuclear or the Scandinavian region on forestry — which risks rather fraught negotiations across the package to ensure that EU states feel that the burden of achieving net zero is fairly distributed across countries and sectors.

In the UK, following a flurry of government strategy papers in the run-up to COP26, attention will also turn to implementation of the Prime Minister’s 10-point plan and the cross-government Net Zero Strategy. With ambitious decarbonisation targets to achieve by the end of this decade, political debate will centre on the cost of ‘going green’ to consumers, as the government seeks to switch energy levies from electricity to gas; to incentivise the take-up of domestic heat pumps to replace gas boilers; and to finance further new nuclear generating capacity. Against this backdrop, further Government-mandated corporate climate disclosures will be rolled out and the Treasury will unveil the UK’s version of the EU’s Green Taxonomy (expected to include nuclear) before the end of the year.

Brexit

The second anniversary of the UK’s exit from the European Union will be marked on 31 January. While day-to-day cooperation at working level between the UK and EU remains strong across a range of areas, the post-Brexit political relationship is characterised by a lack of trust and accusations of bad faith on both sides.

The Northern Ireland Protocol, agreed as part of the original Withdrawal Agreement, is an area of contention. The UK’s challenge to the terms and the implementation of the Protocol has further eroded trust – but also yielded some movement from the EU on goods inspections. However, fundamental UK objections to the role of the European Court of Justice and the application of EU state aid rules are unlikely to be reconciled, meaning antagonism over the Protocol, as well as other sensitive issues such as fisheries, will likely persist. This will continue to weaken EU incentives to enhance cooperation in areas such as migration, scientific research and financial services – continuing to put at risk items such as the Joint UK-EU Financial Regulatory Forum, which was envisaged in the Trade and Cooperation Agreement. 

Cost of living

Rising energy prices and above-target inflation brought cost-of-living issues back into political focus across Europe at the turn of the year. In the UK, the immediate effects are being felt in the retail energy supply market, which is being redrawn with the collapse of a significant number of smaller suppliers, further concentrating the customer base in the hands of the largest providers. If inflation persists, greater political scrutiny is likely to be applied to the costs to households of ‘going green’, resulting in the continuation of the long-run UK fuel duty freeze (potentially delaying the switch to electric vehicles), a delay in the government’s ambition to switch the costs of subsidising green energy from electricity bills to gas bills and pressure to delay the Government’s timetable for encouraging homeowners to replace gas boilers with low-carbon heat pumps. The debate may also weaken enthusiasm for committing to additional new nuclear generation, given the pass-through of part of the costs to consumers.

Similarly, the EU is also concerned about the rising energy prices, triggering conversations about whether such pressures are transient or more long-term and therefore warrant a structural response through reform of EU energy market regulation. The current backdrop of high energy prices and record high carbon prices could also bleed into negotiations on the EU Green Deal where the spectre of the French “gilets jaunes” protests continue to haunt politicians.   

Levelling up

Alongside “Get Brexit Done”, “levelling up” was Boris Johnson’s other 2019 Election refrain. Following the Covid hiatus, the Prime Minister is now under pressure to outline a coherent levelling-up strategy that can deliver benefits to communities – focused outside London and the South East – ahead of the next general election.

With a relabelled a government department to lead the charge, a major policy paper to define the agenda and a set of Government actions is expected soon. However defined, building more homes is likely to be both central to the agenda and one of the toughest political challenges the PM faces next year. The government backed down on previous reforms to liberalise planning rules in the face of a rebellion from Conservative MPs, so a new approach is being devised. Given the impossibility of the government being able to significantly increase the number of new homes being built, in areas where demand is high and while only building on brownfield sites, there is a risk that the new proposals follow the path of their predecessor and the housing agenda remains stuck on the status quo. 

Section 2: Regulatory outlook

  1. Our analysis identifies 5 key themes that will influence the regulatory landscape in EMEA:
  2. Refinement of the framework governing sustainable finance and environmental, social and governance (ESG) issues to address the climate transition.
  3. Continued focus on the resilience and supervision of the non-bank sector and the stability of financial markets more broadly following the March 2020 period of volatility.
  4. New initiatives to enhance retail investor participation in financial markets and continued focus on retail investor disclosures.
  5. Improving the functioning, effectiveness and transparency of financial markets.
  6. Developing the framework governing the regulation and supervision of digital financial services and operational resilience. 

Sustainable Finance and ESG

The continuing development of sustainability- and ESG-related requirements applying to supervised entities will continue to be a priority for policymakers globally. For example, policymakers will continue to commit significant resource to refining the frameworks governing sustainability-related disclosures for products and financial market participants across jurisdictions.

The data required by firms to meet such disclosure obligations will also be a focus as they take forward initiatives seeking to enhance the availability of, and access to, reliable ESG data. In this regard, the development of ESG taxonomies will continue apace, with focus moving beyond “climatemetrics” towards defining the broader environmental social component of such taxonomies.

Additionally, from August 2022, intermediaries in the EU will be required to consider investors’ ESG preferences when distributing investment products, with a significant impact on their activities as well as those of product manufacturers. 

Financial stability

The impact of the Covid-related market volatility experienced in March 2020 has drawn significant attention from policymakers over the last 18 months or so and we expect this to continue in 2022. Indeed, we anticipate policymakers’ analyses to evolve into proposals for regulatory reform to enhance the resilience of the non-bank sector, in particular with respect to the functioning of short-term money markets and money market funds (MMFs), as well as liquidity risk management within open-ended funds more generally.

The European Commission has already put forward amendments to the EU frameworks governing the operation and supervision of retail and alternative investment funds, with the aim of finalising proposals clarifying rules on fund liquidity risk management, loan origination and delegation over the course of 2022. Likewise, in the UK, we expect the Bank of England and the Financial Conduct Authority (FCA) to take forward their joint initiative on enhancing the resilience of the non-bank sector, with a particular focus on finalising a regulatory approach to asset liquidity classifications and swing pricing.

 Retail investing

In the continuing low interest rate environment, and with more responsibility being placed on individuals to plan for their financial futures, improving retail investor participation in financial markets will be a key theme in 2022. For example, the European Commission is expected to bring forward an EU Retail Investment Strategy with the aim of addressing this theme by, in part, enhancing the effectiveness and transparency of the current EU inducements regime. In the UK, the FCA will continue to develop its cross-sectoral Consumer Duty, reinforcing firms’ obligation to consider their retail clients’ best interests when undertaking activities on their behalf. Final rules are expected in Q3 2022.

Policymakers also see improving the usefulness of retail investor disclosures as key to enhancing retail investor participation in financial markets. We expect regulators in the EU and the UK to make changes to the content of packaged retail investment and insurance products’ (PRIIPs) Key Information Document (KID) template in 2022, with EU authorities requiring Undertakings for the Collective Investment in Transferable Securities (UCITS) funds to produce a PRIIPs KID by the end of the year. Separately, work undertaken by ESMA in collaboration with EU national competent authorities last year on UCITS costs and charges, and the ongoing review of the implementation UK value assessment requirements, will increase regulatory scrutiny on the transparency, cost and performance of retail products.

 Functioning of financial markets

Over the last year, EU and UK policymakers have undertaken several consultations assessing the potential effectiveness of proposals to improve the regulatory framework governing financial markets. Looking forward to 2022, we anticipate that policymakers will prioritise initiatives that seek to ensure the emergence of a privately provided consolidated tape (CT) of record for market data, alongside a reduction in complexity of pre- and post-trade transparency regimes. Indeed, the European Commission has already suggested rule changes to this effect.

Moreover, current market-wide reforms seeking to enhance the effectiveness of investment and market infrastructures, such as activities in respect of the London Interbank Offered Rate (LIBOR) benchmark’s cessation or the implementation of the EU’s settlement discipline regime, will also continue in 2022.

 Digital Finance and Operational Resilience

In the year ahead, policymakers in the EU and UK will continue to encourage innovation and the emergence of digital products and services. While significant resources will continue to be put towards existing regulatory sandboxes and pilot regimes, we expect EU-wide and UK rules governing markets in crypto assets to be finalised alongside separate frameworks for the operation of market infrastructures based on distributed ledger technology (DLT). We also expect exploratory work on central bank digital currencies to continue next year, as well as initiatives relating to Open Finance and e-IDs; artificial intelligence; and the development of common data standards.

Finally, there will be a continuing focus, in 2022, on the implementation of EU rules governing cloud outsourcing while, in parallel, policymakers seek to finalise the EU’s new Digital Operational Resilience Act (DORA) within the first half of the year. In the UK, firms across the financial sector will likewise be focusing on implementing the regulatory changes necessary to comply with new rules relating to operational resilience which will apply from March 2022.

Please continue to check back for a range of blog content from us and from some of the world’s leading fund management houses.

David Purcell

14th January 2022

Team No Comments

The Lifecycle of a Green Technology Company

Please see below article received from J.P. Morgan yesterday, which reminds us that green technology is our ticket to a more sustainable future. Despite this, 50% of the technology we need to reach the world’s net zero carbon targets is not yet commercially viable, according to the International Energy Agency.

Meanwhile the other 50% is spread across both rapidly growing, innovative businesses, and more mature, profitable companies. As a result, green technology businesses find themselves at various points on what we call the S-Curve. This creates a range of very different opportunities for investors.

The S-Curve provides a framework for assessing almost every successful technology business since the first industrial revolution, with growth proceeding through three distinct phases – nascent technologies undergoing a burst of innovation, followed by exponential growth as mass adoption takes off, and finally reaching maturity.

Phase 1 – Nascent Technology

The nascent phase is the most volatile end of the curve. A new and innovative company faces a particularly wide range of possible outcomes, and the valuation will reflect the probability of these occurring. For example, a business may be valued at $1 billion today if investors believe there is a 10% chance it could be worth $10 billion in the future – but that valuation still implies a 90% chance it will be worth nothing. So while there can be massive upside if things go right, there is a significant risk it may not.

To move from the nascent phase to mass adoption, new technologies require a catalyst. In the green technology space, catalysts can include government initiatives, regulations, or consumer behaviour.

A good example is hydrogen technology – is it the future of decarbonising transport? The answer to this question may well depend upon the actions of governments. Following the COP26 summit, the US government made some encouraging statements about their plans for green hydrogen, which boosted stocks in the space. However, there still remain multiple fundamental issues, such as the volume of green power needed to produce meaningful quantities of hydrogen. Therefore, predicting whether this will be an area of focus for future government support is a fiendishly difficult task.

Those companies which do achieve mass adoption of their product can deliver windfall returns for early investors. Although it does not eliminate the risk of loss, diversification can be key to managing risk in this phase, as some technologies will simply never take off.

Phase 2 – Mass Adoption

Companies in this phase are those which have already hit their inflection point, leading to fast-growing revenues and a battle for market share.

In the green technology space, electric vehicles are the most visible mass adoption technology right now. Tailwinds here include government incentives and targets (the UK’s goal of banning the sale of new petrol and diesel cars by 2030, for example), as well as the growing number of charging points and advances in battery technology. With such forces behind them, it’s little wonder the likes of Tesla are enjoying huge revenue growth. Surely, it’s just a case of investing in a theme enjoying exponential growth and watching the returns flood in?

Not so fast. A technology theme may be thriving, but that doesn’t mean every company will be a winner. Far from it. In the mid-19th century, the railways were clearly set to be the backbone of Victorian Britain, but of the more-than 250 railway companies set-up, only a handful survived. In fact, a third of proposed rail tracks were never even laid. Some companies will be gaining market share, while others will see their costs spiral and profits suffer. Essentially we’re asking, who is going to be left standing?

There is another way to approach this phase of curve. A common saying is: during a gold rush, it’s best to be the one selling shovels. One way investors can get attractive exposure to the electric vehicles theme is through semiconductor companies, such as Infineon, which supply the chips all electric vehicles need to operate. Whether it’s Tesla, Volkswagen or another company that comes out as the dominant producer, they will all need semiconductors in their cars.

Phase 3 – Maturity

Once everyone who wants an electric vehicle has one, the industry will reach the mature phase of its growth. People may change their car every few years, as they do with their smartphones, but exponential growth will be over.

Wind energy is an example of a mature technology in the green space. Such businesses are no longer so reliant on government support, they generate predictable earnings streams, and many have high quality management teams. Wind farms often have power price agreements that can last for more than 25 years, which results in very stable cash flows.

One such leader in offshore wind is Denmark-based Orsted, a company that generates strong returns from its various projects and has been highly successful in winning large tenders. As investors, we’re interested in what we’re paying for such consistent earnings. This is where company quality becomes even more important, as just small improvements in cost of capital can dramatically increase project values and share prices.

Unlike early and mass adopters, pure economics is a larger driver of mature companies’ fortunes. We’re looking for attractive valuations, earnings visibility, and best-in-class management teams delivering profitable projects while reducing their cost of capital.

In Summary

Green technology isn’t just about trends, it’s about identifying the winners within those themes. For those companies which do grow to dominate the space, the rewards can be huge. Across the S-Curve, we focus on quality, valuation, and diversification – while also looking for the standout winners gaining momentum. Ultimately we aim to invest in the green technology companies that will power our transition to a more sustainable future.

Please check in again with us soon for more relevant content and insight.

Happy New Year.

Chloe

10/01/2022

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Team No Comments

Markets in a Minute: Equities start 2022 on a strong footing

Please see below this week’s Markets in a Minute update from Brewin Dolphin – received late yesterday afternoon – 05/01/2022

Global equities made solid gains in the final week of 2021 to start the new year on a strong footing.

A ‘Santa Claus rally’ helped the S&P 500 reach new record highs and end the week up 0.9%, as fears about Omicron waned. The Dow also gained 1.1%, while the technology[1]focused Nasdaq was flat.

The pan-European STOXX 600 and the FTSE 100 ended their holiday-shortened trading weeks up 1.1% and 0.2%, respectively, with the latter closing near its highest level for 2021, despite surging coronavirus infections.

Over in Asia, the Shanghai Composite advanced 0.6% following encouraging manufacturing data.

Last week’s market performance*

• FTSE 1001 : +0.17%

• S&P 500: +0.85%

• Dow: +1.08%

• Nasdaq: -0.05%

• Dax2 : +0.82%

• Hang Seng3 : +0.75%

• Shanghai Composite: +0.60%

• Nikkei2 : +0.03% *

Data from close on Friday 24 December to close of business on Friday 31 December.

1 Closed Monday 27 and Tuesday 28 December; early close on Friday 31 December at 12:30pm.

2 Closed Friday 31 December.

3 Closed Monday 27 and Friday 31 December.

US indices hit fresh record highs

 The S&P 500 and the Dow hit new record highs on their first trading day of 2022, rising by 0.6% and 0.7%, respectively, on Monday (3 January). Easing concerns about the economic impact of Omicron helped to boost investor sentiment, despite rising case numbers. Bank stocks performed particularly strongly on speculation the Federal Reserve could lift interest rates earlier than expected.

The FTSE 100 also rose in its first trading session of 2022, gaining 1.6% on Tuesday to finish above 7,500 for the first time in almost two years. The IHS Markit/ CIPS manufacturing purchasing managers’ index (PMI) measured 57.9 in December, up from an initial reading of 57.6 although slightly below November’s three-month high of 58.1. Companies maintained a positive outlook at the end of 2021, with 63% forecasting that production would increase over the coming 12 months, compared to only 6% anticipating a contraction.

The STOXX 600 also rose by 0.8% on Tuesday, with travel and leisure stocks surging after the UK’s vaccine minister said Britons hospitalised with Covid-19 are generally showing less severe symptoms than before.

At the start of trading on Wednesday, the FTSE 100 was down 0.2% ahead of the release of the Federal Reserve’s December meeting minutes later in the day.

US jobless claims fall despite Omicron

US weekly jobless remained close to their lowest level for over 50 years in the week ending 25 December, showing the rapidly spreading Omicron variant has yet to impact employment. Initial claims for state unemployment benefits totalled 198,000, less than the 205,000 forecast by economists and 8,000 lower than the previous week, according to the Labor Department data.

US initial jobless claims

Continuing claims – which measures the number of unemployed people who have already filed a claim and continue to receive weekly benefits – fell by 140,000 to 1.72 million in the week ending 18 December. This was the lowest level since 7 March 2020, just before the first wave of Covid-19 lockdowns.

Investors are now waiting for the latest monthly employment figures, which will be released on 7 January. Economists polled by Reuters expect the unemployment rate to edge down to 4.1% in December from the 21-month low of 4.2% in November.

Festive retail sales soar

In another sign that Omicron is having a milder effect on economic activity, US retail sales surged by 8.5% during this year’s holiday shopping season (1 November to 24 December). This was the biggest annual increase in 17 years, according to the Mastercard data. Online sales grew by 11.0% compared to the same period last year, while sales at physical stores rose by 8.1%.

“Shoppers were eager to secure their gifts ahead of the retail rush, with conversations surrounding supply chain and labour supply issues sending consumers online and to stores in droves,” said Steve Sadove, senior adviser for Mastercard. “Consumers splurged throughout the season, with apparel and department stores experiencing strong growth as shoppers sought to put their best dressed foot forward.”

Covid restrictions tighten

Several countries in Europe tightened their coronavirus restrictions last week as infections surged to record levels. In France, where daily infections reached a new high, the government announced that from 3 January people must work from home if they can and public gatherings will be limited to 2,000 people for indoor events. Other countries cancelled official new year celebrations, and introduced limits on bar and restaurant opening hours.

Over in China, which is holding on to its zero-Covid strategy, 1.2 million people were placed into strict lockdown in Yuzhou in the Henan province this week, joining 13 million others who have been locked down in Xi’an for almost a fortnight.

 China manufacturing PMI beats forecasts

China’s official manufacturing PMI beat forecasts in December, rising to 50.3 from 50.1 in November, according to the National Bureau of Statistics. Analysts had expected it to fall slightly to the 50-point mark that separates growth from contraction. Activity in the services sector also grew at a slightly faster pace in December, rising to 52.7 from 52.3 the previous month.

However, China’s vice commerce minister warned last week that the country faces “unprecedented” difficulties in stabilising trade next year. Export gains could slow as other countries recover their production capabilities and inflation eases, Ren Hongbin said.

To view the latest Markets in a Minute video click here

Please continue to check back for a range of blog content from us and from some of the world’s leading fund management houses.

David Purcell

6th January 2022

Team No Comments

Welcome 2022 – Happy New Year! Some less strenuous New Year’s resolutions..

Make your money work harder:

  1. Maximise tax reliefs and allowances.  This will help you get more for your money when investing and planning.  The obvious options are pension funding and using your ISA allowances.  But we have plenty more to use if appropriate.
  2. Have you any lazy capital sitting in cash?  If you have a medium or long term investment horizon, consider investing some of it for real capital growth over time.  Cash buying power is eroded by inflation over the long term.
  3. Do you have any legacy pension and investment assets that have not been reviewed recently?  Are they invested in line with your risk profile, capacity for loss and objectives?  If not, you could be missing out on potential investment returns and/or taking too much risk.
  4. Do you have any spare monthly income?  If you have, you could invest it in either your pension or a Stocks & Shares ISA.  Other investments are also available.

Get your ‘legal’ house in order:

  1. Do you have up to date Wills in place?  If not, please take legal advice.
  2. Have you got both Power of Attorney in place?  One for Finance and Property and the other for Health and Welfare: https://www.gov.uk/power-of-attorney
  3. Are your pension nomination forms up to date on your current Workplace Pension and on any legacy pension assets?  As these are potentially some of your biggest assets, it’s important that your nominations/Expression of Wishes reflect your current situation.  They can drift out of date and legislation can and does change.

Please take independent financial advice and legal advice as appropriate.

Whilst any of the above won’t help you lose weight or get a (better?) beach body they could help you straighten out your finances for your financial good health.

All the best for 2022, have a happy, healthy and prosperous year.

Steve Speed

04/01/2022

Team No Comments

Covid trumps inflation at the top of investor concern for 2022

Please find below an article detailing the impacts of Covid on stock markets and investments, received from AJ Bell yesterday – 19/12/2021

DIY investors are entering 2022 in a mood of constructive realism, recognising market risks, but also largely confident in their investments. Six in ten expect further covid restrictions in 2022, and a resurgence in the pandemic is the number one worry for investors as we head into the new year. Indeed, covid is seen as a greater risk than inflation, which makes sense seeing as the stock market provides some protection from price rises. Inflation comes a close second in the list of concerns for 2022 though, which shows investors are wary of price rises and the effect this may have on their portfolios. Global politics and high stock valuations are also cause for concern for some investors. 

On the whole though, investors see the glass as half full rather than half empty. About 50% were confident or very confident about their investments in 2022, and around four in ten were neutral. That’s also reflected in forecasts for the Footsie, with two thirds of investors (65.7%) expecting the UK stock market to make further ground over the course of the coming year. Almost half of investors expect single digit returns in 2022, which suggests investors aren’t getting carried away, and are settling in for a more modest year for growth than 2021.

Investors are also becoming more attuned to ESG considerations, with four in ten (38.3%) saying these were going to play a bigger part in investment decisions in 2022. There’s already been a groundswell of interest in ethical funds in the last two years, and our survey suggests this isn’t going to abate in 2022. More than two thirds of investors also said they think there should be grater clarity over companies’ net zero plans. 

The ESG agenda has developed so rapidly across the investment industry that the information available to investors is struggling to keep up. The FCA is formulating proposals on a new green labelling regime, expected in the first half of 2022, which should help make things a bit easier for investors seeking ESG investment options.

Please continue to check back for a range of blog content from us and from some of the world’s leading fund management houses.

David Purcell

20th December 2021

Team No Comments

Stock markets stage full recovery after Omicron fears

Please see below article received from AJ Bell yesterday afternoon, which suggests that investors appear to have decided the new Covid-19 variant won’t derail economic growth.

Stock markets hate uncertainty, and the arrival of Omicron has created an information vacuum which is likely to persist until scientists and economists get to grips with the likely health and economic effects caused by the latest variant of concern.

On 26 November, the so-called fear gauge, the VIX index, spiked higher as investors scrambled to hedge their portfolios, sending US markets down by around 2%.

UK and European markets dropped by more than 3% with travel related shares and economically sensitive stocks, such as banks, taking the brunt of the fall.

British Airways owner International Consolidated Airlines dropped by as much as 20% and Lloyds dropped by close to 10%.

Commodities like oil and copper sank as markets moved to price in lower global growth, while interest rates dropped.

Comments from Moderna chief Stephane Bancel prompted another sell-off in markets on 1 December after he predicted a ‘material’ drop in effectiveness from current vaccines against the new variant.

Fed chairman Jay Powell added to uncertainty on the same day after he surprised markets by saying the US central bank would discuss an increase in tapering (removing stimulus) at the December meeting, which sent bond yields higher and prices lower.

Elevated volatility saw the VIX index climb from 18.58 on 24 November to 31.12 on 1 December. Historically, large spikes in the VIX index have been associated with ‘market capitulation’ and higher future stock prices.

Sentiment already appears to be shifting. The VIX has since dropped back to 22.02 and at the time of writing (7 Dec), the FTSE 100 index had recovered all its losses since the variant first dominated the headlines, and was trading slightly above pre-Omicron levels.

The index has been helped by a strong rebound in index heavyweights Royal Dutch Shell and BP.

After falling as much as 15% on Omicron worries oil prices have staged a recovery rally following a meeting of oil producers’ cartel Opec+ (Dec 2) where Saudi Arabia and its allies agreed to press ahead with efforts to increase production by 400,000 barrels a day each month.

Opec+ also hinted it would adjust production if necessary, which seems to have provided support to prices. Brent Crude has risen by around 8% to $71.70 per barrel since the meeting.

Before the Opec+ meeting several countries including the US, China and the UK had indicated they would release supplies from their strategic oil reserves to help curb prices.

We endeavour to publish relevant content and market news regularly throughout the festive period, so please check in again soon.

Chloe

10/12/2021

Team No Comments

Could Omicron derail the US equity bull market?

Please find below a ‘Markets in a Minute’ update, received from Brewin Dolphin, yesterday evening – 07/12/2021

The S&P 500 has surged over the past 20 months. Could the spread of the Omicron variant spark the first correction of the bull market? Paul Danis, our Head of Asset Allocation, provides context and discusses the outlook.

Last Friday saw a sell off in higher risk asset classes when the Omicron variant of Covid-19 suddenly landed on everyone’s radars. The news was poorly received as many investors had become quite relaxed about the virus. The S&P 500 fell 2.3% – its biggest one-day loss in nine months – while the pan-European STOXX 600 slumped 3.7% in its worst session since June 2020.

Economic growth-sensitive plays like small caps underperformed. At the industry level, it was the travel[1]sensitive airline, hotel, restaurant and leisure sectors, oil-sensitive energy plays, and yield-sensitive banks that were among the worst hit.

Where do we stand now after the Omicron[1]induced sell off?

Notwithstanding Friday’s selloff, global equity markets have surged over the past 20 months, led by the US. As of the end of November, the MSCI All Country World Index is up 89% (in US dollar terms) from the March 2020 low. The US large cap benchmark, the S&P 500, is up 104%. We focus on the S&P 500 in this article because it represents over 60% of the global equity market cap, it acts as a bellwether for equity bourses around the world, and US equities constitute our largest overweight position.

Although there have been several US equity bull markets that have seen much greater total price appreciation than what has occurred so far this cycle, what has made this cycle’s bull market stand out is the intensity of the rally. This cycle, the S&P 500’s annualised performance since the bull market began is just over 62%. Looking at all the bull markets where the total gain has been at least 100%, one must go back to the early 1940s to find rallies that have been as intense.

What’s more, we have now gone much longer than the average length of time without seeing a 10% correction in the S&P 500. Since the late 1920s, the average time between the start of a bull market and an S&P 500 decline of 10% or more is about a year and two months. This cycle, we’ve gone about a year and eight months without a 10% correction. The worst we’ve had was a 9.6% decline in September last year, and a milder 5.5% pullback in September this year.

Is Omicron enough to spark the first 10% correction of the bull market?

It’s possible. How much downside we get will be determined by what the data show in terms of Omicron’s ability to evade vaccines and natural immunity, as well how dangerous it is. The good news is that a lot of work has already been done to find solutions to Covid-19. As such, if it turns out that Omicron poses a new serious challenge, the world is in a better place now to address it.

Preparing new vaccines is not trivial, but it would be a shorter and more certain process than the development of the original vaccines. Furthermore, we also have some effective treatments for Covid-19. These are not expected to be impaired by the new variant.

When compared to the historical averages cited above, the S&P 500 bull market is looking long in the tooth. Other concerns include extended valuations, profit margins that are at risk of turning lower, and the likelihood that we may soon enter a slower growth phase in the global economic cycle. With all this in mind, the next 12 months are likely to prove bumpier than the past 20 months for equity investors. Nevertheless, it looks like the equity bull market is still on a solid foundation. Importantly, The S&P 500 has surged over the past 20 months. Could the spread of the Omicron variant spark the first correction of the bull market? Paul Danis, our Head of Asset Allocation, provides context and discusses the outlook. Could Omicron derail the US equity bull market? 01 December 2021 we believe the economy will continue to expand at a healthy pace. Based on cycles from 1990, the S&P 500 peaks on average two months after the unemployment rate begins to rise.

 Is there continued scope for the labour market to improve?

 The US unemployment rate has already dropped a lot. It is currently at 4.6%, significantly lower than the April 2020 high of 14.8%. The Omicron variant creates new uncertainty, but most of what we are seeing suggests it will go down further. Importantly, US households are still sitting on roughly $2.5trn in excess savings built up during the pandemic. True, there have been signs of weakness from the all-important US housing market, such as housing starts. But that does not appear to be because of weak demand. Rather, supply bottlenecks appear to be the problem, with homebuilders struggling in terms of hiring workers and with the high price of building materials. Housing units authorised in the US have attained new highs, which likely indicates some pent-up demand.

Is there anything else supporting the equity market?

 There are some silver linings to the Omicron-induced sell off. On the greed and fear spectrum, the Omicron news turned the dial meaningfully toward the latter. On that front, the market’s ‘fear gauge’, the VIX index, hit the highest level since February on Friday. A healthy level of fear in the market tends to be more supportive of future gains compared to a backdrop of greed/complacency.

In addition, the market is now pushing back expectations of Federal Reserve interest rate hikes. The Fed’s continued willingness to stimulate the US economy, by keeping interest rates low, is also something that should support equities.

Aren’t equities now just too expensive?

It is true that equities are expensive by historical standards. But so are bonds, and investors are disincentivised to hold cash, thanks in large part to the Fed’s accommodative policy stance. The inflation-adjusted ‘federal funds rate’ is currently below -4%. This means investors’ cash holdings are depreciating in real terms at an annualised rate of over 4%. These low real yields on cash and bonds combined with solid corporate profits growth are keeping the yields on equities at relatively attractive levels even after such a strong rally.

So, you remain bullish – what are the risks?

Omicron is clearly a big one. Another is that the Fed will end up tightening policy sooner than most expect. This could happen if long-term inflation expectations change. While ten-year inflation expectations implied by US inflation-linked bonds are elevated, they are not at extreme levels. Other measures of inflation expectations also suggest the market is not overly concerned about inflation over the longer-term. While there’s no room for complacency on inflation, the data are not behaving in a way that would make one believe the Fed will imminently pull the rug out from under the equity market.

Conclusion

The emergence of the Omicron variant is undoubtedly a concern. Nevertheless, on a 12-month view, we believe that a continued overweight in equities and underweight in bonds is appropriate. Equity investors are likely to be in for a bumpier ride over the next year. But with the economic outlook still largely positive and given the Fed’s currently supportive policy stance, it looks like the equity bull market remains on a reasonably solid foundation.

Please continue to check back for a range of blog content from us and from some of the world’s leading fund management houses.

David Purcell

8th December 2021

Team No Comments

Flexibility will be key in 2022

Please see below article received from Jupiter yesterday afternoon, which reviews a tumultuous period for markets and looks ahead to 2022, where flexibility will be essential in a volatile investing environment.

“Life moves pretty fast. If you don’t stop and look around once in a while, you could miss it.” – Ferris Bueller, Ferris Bueller’s Day Off (1986)

We leave it to the readers’ imagination why a film about a high school slacker resonates with the Multi-Asset team. But the post-pandemic period has been one of the most intense of our careers – it’s all too easy for investors to get caught up in the market narrative. Our job is to take a “day off” from the hyperbole and make sense of what’s happening. We predicted back in April 2020 that the sugar rush of pandemic stimulus would kickstart a warp-speed business cycle, and it did. After the fastest recession there was the fastest recovery in history, and now markets are worried things are moving too fast. The market narrative has flipped from deflation to reflation to stagflation to inflation in a matter of weeks.

Don’t rely on inflation fading next year

The Federal Reserve (Fed) has allowed monetary policy to run looser for longer, as we expected after the structural shift of its 2020 framework review1. There has been an even faster rebound in demand than the Fed expected, driven by vaccines, rising household wealth, and stimulus cheques. Demand has outstripped supply resulting in inflation levels we haven’t seen for nearly 40 years.

The Fed is banking on inflation fading next year, but it may be more persistent . We analyse current inflation across four key buckets: reopening-related sectors, housing, wages, and expectations. All are moving higher. Inflation in rents is sticky and can contribute to higher inflation expectations, which reinforce longer term inflationary dynamics. Central bank policy is running a risk of going too slowly now, and having to move at a faster pace further down the line, choking the recovery.

Heading into 2022, we think growth can be sustained and support markets. Supply bottlenecks have left inventories low, and restocking can sustain industrial production. Accumulated savings (of around 10% of GDP in the US) can continue to support consumption. As we head towards the middle of next year, restocked inventories, slowing consumer demand, tighter policy and stretched valuations will make life more difficult. Conclusion: one can continue to ride the wave in equities and hold fewer bonds for now, but the likelihood is the flexibility to cut risk and add duration later next year will be needed.

Job openings are outstripping the supply of unemployed workers, putting upward pressure on wages

Looking beyond the horizon

Looking out into the more distant future, structural shifts point to a modestly stronger growth and inflation environment. Pandemic stimulus cheques and asset price rises allowed an increase in retirements, reducing labour supply, but lifting wages. The pandemic and trade wars exposed global supply chains, leading to a structural shift from “just in time” to “just in case”. We have seen increased capital expenditure and in particular increased spending on research and development since the pandemic, which can drive productivity and growth. Last but not least, the need to fund climate transition can unlock additional fiscal spending and potentially forms of ‘green’ stimulus. There seems to be little chance of a return to the austerity of the previous decade.


These factors will take some time to play out, but the sum of their impact is likely to be a modestly higher growth and higher inflation environment over the next decade, particularly compared to the previous one. Shifting policy is also likely to lead to higher volatility, and more frequent, sharper crises. Simple balanced portfolios of higher quality equities and longer duration bonds are unlikely to work as well as they have.


This doesn’t necessarily mean investors can’t make decent returns, but it will call for different approaches. As Ferris said, “you’re not dying: you just can’t think of anything good to do”. We think this sentiment applies to investing: you can still perform, but you will need more flexibility and a wider range of return sources.

Please check in again with us soon for further relevant content and news as we continue through the festive season.

Stay safe.

Chloe

02/12/2021

Team No Comments

Omicron and Markets – Our Asset Allocation team’s key beliefs

Please find below a insight into the impact of the Omicron variant on world markets, received from Legal & General yesterday afternoon.

 The COVID-19 situation had not been looking good across Europe anyway, but at least there was the hope that the shift into an endemic scenario was not far away, especially with a re-acceleration in vaccinations, boosters and the availability of antiviral drugs. This may well still be the case, but the emergence of a new variant of concern has added to the tail risk that it won’t be.
 
Déjà vu all over again

We are neither virologists nor epidemiologists. But from a market perspective, there are a few things we can say about the virus without their expertise.

It’s still very early and there is little data about B.1.1.529, now known as ‘Omicron’, but it appears to be spreading faster than the Delta variant did in South Africa. It has many mutations that in other variants have been associated with greater transmissibility and evading immunity.

The variables we will be watching most closely are:
Is it more transmissible?
Is it more likely to lead to hospitalisation and is it more lethal?
Do vaccines and antivirals still work against it, and how well?

We must also consider the response of policymakers. It’s relatively easy for major central banks to do nothing for the time being, should market worries intensify. Rates are already at zero with some tapering underway. It’s a bit trickier for the Bank of England, given expectations of a December hike, but the Federal Reserve (Fed) does not have to speed up tapering in December.

Fiscal support, if needed, should be no different than in previous waves. In Europe, the past few weeks have shown that countries increasing restrictions are just as willing to renew fiscal support measures as previously. In the US, Democrats being in control of both the House and Senate – and with an election coming up next November – should make building consensus to support the economy easier than in 2020.

Restrictions have already been ramping up in Europe in response to the winter wave. New variant concerns could accelerate this dynamic. The US faces a different situation, as a new variant would require a greater shift from the status quo. China’s zero-COVID strategy would be more difficult to maintain with a more transmissible variant.

Mandatory vaccination has already become more likely in several European countries, and a new variant could push more towards this step. This would have little immediate impact on markets, but could potentially be positive for 2022.

Markets will clearly remain sensitive to news on the variables mentioned above. But our initial line of thinking is that, should market weakness around a new variant intensify, similar to geopolitics, it could create an opportunity to increase risk in portfolios.            

M&A: here to stay?  

Until Omicron, the most interesting financial story in late November was merger and acquisition (M&A) activity, sparked by KKR’s* bid for Telecom Italia*.

From an equity perspective, we see M&A as a coincident indicator rather than a leading indicator in the market cycle. It’s more the case that M&A is up because markets are up, rather than markets rallying because of M&A, in our view. Business confidence has typically been the main driver of corporate M&A. Of course, cheap financing also helps, especially for private-equity transactions. Interestingly, M&A activity tends to be highest when share prices are highest. M&A happens not when it’s cheapest to buy, but when management teams feel confident about the future.

We therefore agree with our colleagues’ argument that headline-grabbing M&A can be a late-cycle indicator, but is not necessarily a leading indicator of the end of the cycle. We expect the M&A theme to be with us for the duration of this cycle and bull market, even if financing conditions become less favourable as the cycle matures. One precedent is the Fed rate-hiking cycle from 2004 to 2006, when M&A activity accelerated and kept going until the economic cycle and bull market ended.

Another macro factor that could become less favourable, but seems unlikely to derail overall activity, is US regulation. The Department of Justice and Federal Trade Commission, under new leadership, are trying to enforce antitrust rules more strictly than in the past. This is probably mostly targeted at big tech, but might also put off some other acquisitions that are borderline on antitrust and industry concentration. Aon* and WTW* was one recent example.

For equities, actual deals don’t typically have a positive first-round effect. The shares of the acquirer typically trade down, and the shares of the target trade up, but the target is usually smaller. So, if anything, it’s generally better for small-caps than large-caps. We had a good example in the telecoms sector last week. Telecom Italia was obviously up significantly following the KKR bid. But on the same day, Ericsson’s shares fell 5% on its planned acquisition of Vonage in the US.

Private equity aside, there is another incentive for corporate buyers to consider M&A. For most of this year, companies that have undertaken cash or debt-financed M&A have outperformed companies using cash for buybacks and capex. So, for management whose compensation is linked to the share price, M&A has a definite appeal.    

Earnings 2022  

Of course economic data matter. Of course COVID-19 matters. But for equities, the main reason they matter is because of what they tell us about corporate earnings.

Coming out of a solid third-quarter 2021 earnings season and heading into year-end, it’s a good time to think about what earnings will look like in 2022. The obvious caveat to all of the below is that a dangerous variant would change everything.

Our economics team’s roadmap is consistent with US earnings growth in the high single digits, more specifically around 9% by the end of 2022. That would be a slowdown from the post-recession extremes, but solidly positive and a bit above trend.

The 9% estimate is unusually close to the bottom-up consensus of 8.5%. Bottom-up forecasts were too pessimistic about the post-recession rebound, but our own analysis suggests that the big upward revisions to analyst expectations should soon come to an end. It’s too early to tell for sure, but the top-down numbers from sell-side outlooks also appear to sit in the high single-digit area.

The biggest swing factors to next year’s earnings, COVID-19 aside, are US corporate taxes. Assuming about half of the initial proposals from the Biden administration become law, that would take around 5% off earnings growth estimates. The latest proposals, however, have come in a bit smaller than previously. It’s possible the statutory tax rate could stay unchanged, with reforms focusing instead on foreign income, a minimum tax rate and a buyback tax. So the hit to US profits could end up being smaller than 5%.

Another factor to consider is slower economic growth in China, given that we are at the bearish end of forecasts for the country’s GDP. However, the first-order impact on US profits should be manageable. We estimate that 1% off Chinese GDP growth takes a bit less than 1% off S&P 500 profits. Given the other uncertainties around earnings growth, this should not be a dominant driver of the US earnings debate next year.

*For illustrative purposes only. Reference to a particular security is on a historical basis and does not mean that the security is currently held or will be held within an LGIM portfolio. The above information does not constitute a recommendation to buy or sell any security.    

Please continue to check back for a range of blog content from us and from some of the world’s leading fund management houses.

David Purcell

30th November 2021