Three managers give their views on inflation, the economy and the outlook for 2022, November 2021

This week, Darius McDermott, managing director of Chelsea Financial Services, hosted a dinner for the financial press. Speaking at the event were two Chelsea Selection managers and M&G’s head of fixed interest.

Here is what they had to say about inflation, the global economy, and the outlook for next year.

Jeremy Podger, manager of Fidelity Global Special Situations

“There are a few key questions in the market at the moment. The first is: will global growth disappoint? We’ve seen downgrades to estimates over the past few quarters due to the Delta variant and supply issues. But the US Economic Surprise Index that led downgrades recently is now turning more positive. I think the global economy will be relatively strong next year, just not as hot as it has been this year.

“The next question is: have we moved from good inflation to bad inflation? Now, inflation is less transitory than people first thought and it’s true that energy and materials have hit a level they were last at in the 1970s when there was demand destruction. So, we need those pressures to ease. But the labour market is improving, so the conditions for stagflation (when you have high inflation and high unemployment) are not there today.

“It’s different for different countries though. Japan for example, has had many phases of currency depreciation and stimulus, but nothing has helped create inflation as there is a deflationary mindset: the labour market expects wages not to go up.

“The US is more subject to market forces, but even here, most wage growth has so far been driven by lower paid workers. Professional and qualified workers haven't seen it yet. What we need to look out for next is rental inflation. House prices are up some 16% year-on-year in the US and the rental market is following.

“Europe is somewhere in between and there is no sign yet of pressure in the labour market even though there are some shortages in certain sectors. And the UK is difficult to fathom. We don’t have the collective bargaining power we had 30 years ago, so I think real wages are likely to be under pressure for a while.

“Then there is the question of the Federal Reserve (Fed) and by how much the US central bank could raise interest rates. Nothing hurts equities more than unexpected tightening. But the Fed and markets seem to be on the same page, and we are unlikely to see any negative surprises.

“At the moment the 10-year inflation expectation in the US are for 2.6%. If it goes over 3% there is the danger the Fed gets too far behind the curve, and we have to worry about more aggressive rate rises. That situation would be bad for equities.

“Of all the world’s markets, Japan is looking reasonable. We’ve seen progressive improvement in profitability, but that is a multi-year journey. The government - under the new prime minister - should remain constructive towards Japanese companies and next year’s earnings growth expectations are conservative in my view. Valuations are also good, so I think it is an interesting area for 2022.”

Jim Leaviss, manager of M&G Global Macro Bond

“In January 2022, no doubt every outlook piece will once again be calling the end of the great bull market in fixed income… for the 30th year in a row. But I don’t believe this to be the case.

“We have huge global demographic change and an increasing need for income as the world population ages. This trend will continue for decades to come.

“Technology has also led to huge improvements – the industrial revolution, the lightbulb, the internet, etc and that is still the case today: we can find the cheapest goods and source them from anywhere in the world. Globalisation is also making things cheaper and capital flows are keeping prices down. So nothing has changed.

“The question today is, is inflation transitory or here to stay? And even if it is, is there any point in raising interest rates at this time? The Bank of England probably will do so next month, but it’s not going to increase the availability of container ships which is part of the inflationary cause today.

“Oil prices need to go up to about $200 in the next year for energy inflation to stay where it is today – which I don’t think will happen. The worry though is that 80% of the inflation ‘components’ in the US are above 2% today, so it is broad-based. 40% of US inflation is also from rent, which operates on a long lag to house prices which have gone up a lot.

“Therefore, there is a worry that inflation could stay at these elevated levels for some time to come. But wages are not rising by the same amount, which could eventually kill that inflation. Traditionally, manufacturing has always dampened inflation by threatening to move to countries where there are lower wages. Today, working from home means that any worker can do a job from anywhere. So, wage pressures should be ameliorated.

“Today, the big risk is that US consumer confidence has collapsed and, when it falls as much as it has, it can be an indicator of recession next year. The yield curve has also flattened - although not inverted yet, which is another recessionary sign.

“Of all the bond markets at the moment, I favour emerging market bonds over one and five years. There will be lots of volatility and bad headlines, but real yields are 3-4%."

Rob Brewis, co-manager of Aubrey Global Emerging Markets Opportunities

“Emerging markets is an odd collective of countries that no one knows how else to categorise. Some aren’t even really emerging anymore – like Taiwan and South Korea, and even China really.

“So as a company, we are very much focused on the emerging market consumer and each market is at very different stages of development in this respect. And the largest consumer markets are of course China and India – each with 1.4 billion potential consumers.

“I’ve been investing in India for 30 years and while the stock market has done well, the economy hasn’t so much. But we are more optimistic about the Indian economy today and we may be at the stage where India has its moment. Trade, services… everything is in a better state and both manufacturing and infrastructure are finally happening. The inflation genie has also been put back in the bottle.

“The trouble is, the market has noticed this, and the Indian stock market has had a very strong run, so we are a little more cautious about Indian equities going into 2022 as valuations are high.

“China, on the other hand, is coming to the end of 20 years of 10%+ annual growth. Urbanisation is almost complete, and the economy is now slowing. But we also think the doom and gloom has been overdone. We don’t expect China to collapse, and the property sector issues have been a hinderance rather than a major issue.

“The balance sheet of the average Chinese is very property and cash focused and it’s time they spent some of the savings. And that’s a generational change. Millennials and Gen Z are very different to their parents.

“The regulatory changes this year have clouded things, but they are understandable changes: they are common sense, anti-monopolistic and looking after consumer and worker welfare. Many governments around the world would have loved to do what they have done.

“On the environmental side, people may be surprised how much China and India actually do. They wouldn't commit at COP26 as they feel it’s double standards for them to be asked to clean up our mess, but they will act decisively because their populations want them to. Both countries will also do more to lower the cost of energy and batteries than the rest of the world.

“If I had to pick one market only, over one year I’d back China, over five years I’d pick India.”

Past performance is not a reliable guide to future returns. You may not get back the amount originally invested, and tax rules can change over time. The views expressed are those of the fund managers, and do not constitute financial advice.

Published on 22/11/2021