DG Partners

“IF THE MARKETS’ HOPES THAT INFLATION IS TAMED AS WE MOVE TOWARDS THE END OF THE YEAR ARE NOT FULFILLED, THEN EQUITY VALUATIONS MAY BE CHALLENGED AND AUTHORITIES MAY HAVE DIFFICULTIES CONTAINING INCREASED VOLATILITY AND A BIG BEAR MOVE WITH THE LIMITED MONETARY POLICY OPTIONS OPEN TO THEM AT THAT TIME.”

DAVID GORTON

CHIEF INVESTMENT OFFICER, DG PARTNERS

Monetary tightening is inevitable through the first half of 2022. However, with global debt levels now over 250 per cent of GDP, it is highly unlikely that real policy rates can reach zero, let alone return to a ‘normal’ positive. This will leave Central Banks and markets hoping that higher prices destroy sufficient demand to bring inflation down further in the medium term. Continued negative rates and high nominal GDP growth will support asset prices in the near term and new highs in equities are likely to continue being made through Q2.

Commodities, having performed exceptionally well last year, are expected to continue their bull markets and will likely be buoyed by a number of factors. Above trend nominal growth, lax monetary policy, high infrastructure spend and ESG policies are tailwinds for markets already suffering from medium term under-investment. The interlinkages across commodity markets and often intense energy usage in their production, risks an upward spiral in prices. High input costs have already seen rapid increases in fertilizer costs, threatening food supplies next year. Governments may well be inclined to monetise these higher prices rather than allowing market forces to work through. Risks to this outlook include another more deadly wave of Covid hitting and cratering demand. Whilst this is a major tail risk, we believe it more likely that outbreaks will become less severe over time as vaccine programs, new drugs and society as a whole adapts. Risks from a deleveraging Chinese economy remain and may be a headwind for global growth, but the authorities are already easing policy where necessary to prevent a disorderly slowdown. And as both sides quietly attempt to assert their global agendas, a significant escalation of US-Sino relations seems unlikely under a more diplomatic US administration. If the markets’ hopes that inflation is tamed as we move towards the end of the year are not fulfilled, then equity valuations may be challenged and authorities may have difficulties containing increased volatility and a big bear move with the limited monetary policy options open to them at that time.