Short term inflation risks have been overstated
As mentioned last month, the risk to short-term inflation that prompted higher bond yields has been somewhat exaggerated given the excess capacity in the global economy, particularly in the labour market in light of the fact that aggregate global GDP is not yet back to pre-pandemic levels. While we remain concerned about the long-term impact of very expansive fiscal policies and money creation around the world, the impact of these is sufficiently far enough away in the investment horizon to not be of immediate concern for markets. As the vaccine rollouts continue apace around the world, it is clear that forecasts for global growth and corporate profits are undergoing positive revision resulting in forward P/E ratios returning to roughly their pre-pandemic levels.
Major central banks remain committed to maintaining easy monetary policy for at least the next couple of years and as a consequence, defensive assets offer very low returns which will continue to channel investment flows into higher risk assets such as shares.
Vaccines are working well
A key tenet of our investment strategy is that the global economy will progressively reopen coincident with the vaccine rollout. While it has become popular to dramatise the rare side-effects associated with the Astra Zeneca and Johnson & Johnson vaccines, in general, vaccines (especially Pfizer and Moderna) have proved very effective in combating the most serious effects of COVID 19. For example, the Pfizer vaccine is still exhibiting a 91% efficacy against infection six months after the initial vaccination, a much better durability than was originally anticipated. It is also now evident that the vaccines are effective against the new variants that have emerged and provide protection against both infection and transmission. Countries such as Israel are an interesting test case as 58% of the population is now vaccinated and as a consequence, they are witnessing a sharp drop in infections, hospitalisations and deaths. The US is vaccinating 3 million people a day and now has 29% of the population protected. This number would actually be much higher when accounting for people with natural immunity from prior infection.
While there were always going to be production and distribution difficulties to conduct such an unprecedented global vaccination program, there is good cause for confidence there will be a progressive reopening of the global economy towards the end of 2021 and into 2022 which will benefit corporate profits and share prices.
We remain confident on the outlook for shares, especially in offshore markets, in fact our confidence has improved with greater certainty about earnings recovery and more reasonable forward valuations. Challenged by a spike in bond rates last month, the market’s resilience was also comforting. Defensive assets such as cash, term deposits and conventional fixed coupon bonds remain unappealing, and our preference is to hold inflation-linked bonds for equity risk mitigation and downside protection.