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August Strategy Meeting: Peak Growth, Peak Liquidity

By Adam Jones

Having historically been a relatively quiet month owing to summer holidays, August proved no exception as most regional equity indices delivered low single digit returns while developed market sovereign bond yields traded in a fairly narrow range.

The Jackson Hole Economic Symposium panning August 26th to the 28th had been eagerly anticipated by market participants who were keen to gain some insight as to the Federal Reserve’s current thinking on macroeconomic data and monetary policy. As a reminder the Federal Reserve has a dual policy mandate tasked with fostering economic conditions that achieve both stable prices (i.e. average inflation of 2%) and sustainable employment, with Chair Powell having the difficult task of presenting the FOMC’s current thinking on these issues in his speech on August 27th.

Turning firstly to inflation we received confirmation that the Federal Reserve now views this side of its mandate as having been fulfilled. From a short-term perspective, Powell noted the concentration of price rises in the durable goods sector which the Committee continue to view as temporary due to ongoing supply constraints and staff shortages.

Longer term measures of inflation also remain well anchored. In terms of wages there has been some mild upward pressure but only to an extent that is consistent with the Fed’s longer-term objective of 2%.

From an employment perspective the data has continued to improve in recent months although it is worth noting that total US employment is running some 6 million jobs below their February 2020 level (5 million of which are within the service sector). Whilst the total unemployment rate has declined to 5.4% the Committee believes this is “still much too high….and significantly understates the amount of labor market slack”.

Payrolls are expected to have increased by an additional 732k in data released this week and a simple (perhaps optimistic) extrapolation of this rate would imply a full recovery in 8 months time. As such the Committee maintained expectations that they will begin the tapering of their balance sheet prior to year end 2021. Interestingly, however, Chair Powell was very keen to emphasise the separation between balance sheet tapering and hiking rates;

“The timing and pace of the coming reduction in asset purchases will not be intended to carry a direct signal regarding the timing of interest rate liftoff, for which we have articulated a different and substantially more stringent test………

Jerome Powell – Jackson Hole, 27th August 2021

As such our view is that the Federal Reserve will indeed proceed with tapering, perhaps at some point as early as this month. This marks the beginning of a slow withdrawal of liquidity in a market that has very much become accustomed to its provision.

On top of this liquidity withdrawal we also of the view that the peak of accelerating economic growth is now firmly in the rear view mirror. Many of our cross-asset cyclical indicators have been telegraphing this deceleration for several months and have since been confirmed by lower readings across leading economic indicators.

This confluence of factors causes us to adopt a more cautious approach toward markets in the very near term.

One market we are monitoring closely is China, which has seen a very high degree of volatility in recent months as a direct result of government actions. The Chinese government have been tightening their grip on the internet & technology sector since late 2020 through various investigations into monopolistic practices and offshore listings, which have only intensified over the course of 2021 to date.

In our view the crackdown stems from China’s crudely implemented effort to redistribute capital and human talent toward specific sectors within Technology (outside a narrow subset of dominant e-commerce names). The 14th 5-year plan (2021-2025) was released in February of this year and very clearly prioritised the pursuit of ongoing innovation and an increase in technological self-reliance across ‘core’ sectors such as semiconductors and biotech.

The second aspect of their relates to equality. The online Education sector has effectively been forced (via regulations implemented in late July) to become a non-profit sector, with the aim being one of ensuring education is more accessible to its lower earning citizens.

Both of these episodes serve as a useful reminder of the risks inherent to investing in a socialist economy, however we believe recent volatility has also created a number of interesting opportunities in individual businesses.

From a macro perspective China is also not immune from the wider slow-down in global economic data, with the New Orders component of the Chinese Manufacturing Survey having recently fallen into negative territory and the spectre of default risk having risen from the likes of China Evergrande (China’s 2nd largest property developer).

As such the PBOC has already moved to reduce the reserve requirement ratio (the amount of capital banks are required to hold against their lending portfolios) and just last week alluded to likely doing so again in the near future. Allied with a more positive outlook for fiscal expenditure into year-end we expect more accommodative policy to deliver support for Chinese equity markets.

Our investment strategy committee, which consists of seasoned strategists and investment managers, meets regularly to review asset allocation, geographical spread, sector preferences and key global market drivers and our economist produces research and views on global economies which complement this process.

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