July 26, 2021
George Lagarias, chief economist at Mazars on three things for investors to note from last week.
- Despite the bounce, the Delta variant is still advancing and weakening supply chains in developing economies, pushing inflation up and potentially undermining the growth rebound. Equity prices may not presently reflect that.
- It is very rare for stocks to correct during a robust earnings season. It is not uncommon that they do so once positive catalysts are less potent.
- Investors need to keep an eye at the balance between inflation and central bank accommodation. Any comment, no matter how insignificant, towards hawkishness could significantly unnerve markets in the next few months.
“Last week featured a quick market correction on Monday which looked inconsequential by Friday when the market completely bounced back. The result was even higher equity prices (further supported by another very good earnings season with 88% positive surprises) and even higher bond prices. The rebound was relatively narrow, however, with tech stocks leading the charge a week ahead of their own results announcements.
“The issue for portfolio managers is less about equities, which are primarily supported by an abundance of cheap money looking into a limited opportunity set and more about bonds. If inflation creeps in, central banks may have to slash accommodation.
“There are three reasons to hold bonds at such low yields: diversification and risk management (which still works), a mandate (plenty of pension funds have a mandated allocation to fixed income) and the certainty that no matter how expensive the asset is, someone will be willing to take it off your hands at a higher price.
“That last part, primarily affecting ‘fast’ trading money which has been contributing to falling yields for some time, is important. If central banks taper asset purchases and find themselves behind the inflation curve, the hit on a bond market conditioned for a decade to rely on government support could be material. If inflation persists, asset allocators have to make sure their sources of income are diversified and that their choices prepare them for a re-rating of the world’s largest investment asset class.”