With our recent concerns about China somewhat allayed, the case for a medium-term positive stance is reinforced: a global economy in mid-cycle, excess savings, neutral investor positioning and committed support from central banks. That said, we still believe that there are three significant risks on the horizon:
1. The virus: The vaccine roll-out has proceeded relatively smoothly, but even in countries where a large share of the adult population has received two doses, the virus still rages to varying degrees. Global cases are currently uncomfortably high, but steady. Where do we go from here as the weather cools in the northern hemisphere (home to 87% of the population)? The path to full normalisation is far from clear, with travel and tourism likely to be disrupted for some unspecified time to come. There is also the prospect of further mutant strains and waning vaccine efficacy. We continue to scour data, news articles and academic papers for the latest insights.
2. Stagflation: The virus is not good for growth, but neither is inflation. Supply disruptions are persisting for longer than anticipated and shipping container rates continue to soar (as demonstrated by the chart below). The timing is bad as retailers look to replenish exceptionally lean inventories ahead of strong seasonal demand around Christmas. Will the shelves simply be empty, or will prices rise sharply to curb demand? The UK could be particularly badly impacted due to Brexit-related disruption. How might the Bank of England react to a large inflation overshoot at a time of uncomfortably high inflation expectations and anecdotes of labour shortages and building wage pressures? We also don’t know how the end of furlough will impact these dynamics.
3. The US debt ceiling: By not attaching an increase in the debt ceiling to the latest round of fiscal stimulus, the Democrats are playing a game of chicken with Republicans, who may well refuse to support an extension of government funding at the end of September tied to raising the ceiling. Republicans might see this as a way to protest against ‘reckless’ Democrat spending and deficits. This raises the spectre of a government shutdown, which could run into the still-unknown date of when the debt ceiling would be breached. While it is inconceivable that the US would actually default, what kind of concessions or market reaction would be necessary to force Congress to compromise?
As the summer draws to a close and we prepare to enter the final quarter of the year, we will be keeping a close watch upon the evolution of these and other investment risks on the horizon, as the longer-term effects of the pandemic and the measures taken to mitigate its impact upon society and the economy continue to unfold.