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Can bad news still be good news for investors?

23 July 2021
ECB

Jonathan Marriott, Chief Investment Officer

While equity markets collapsed during the initial phase of the pandemic, the monetary and fiscal stimulus came to the rescue of investors, and stock markets recovered. Stock market increases in the first few months of this year were moderated both by inflation fears and the expectation that the monetary stimulus would be withdrawn sooner rather than later. During this period, the stocks hardest hit by the pandemic continued to outperform as the vaccine rollout progressed. Although headline inflation has risen, a detailed examination of the components has shown that most of the rise may be transitory and related to the reopening from the pandemic. As a result, fears of inflation moderated, bonds recovered some of their losses and growth stocks outperformed again.

Monday 19th July, dubbed “Freedom Day”, saw the removal of many of the restrictions we have lived with for months. This could have been seen as good news for equities, but actually saw a sharp sell-off in stock markets around the world and a rally in bonds. As the week has progressed, the equity market recovered, underlining the fickle nature of short-term moves.

The European Central Bank (ECB) meeting this week once again stressed that the progress of the pandemic, and the Delta variant, clouded the horizon. In the UK, there have been rising COVID-19 cases affecting younger people in particular, despite a high proportion of the population being vaccinated. However, it does appear that the vaccine leads to less severe cases. From an economic perspective, the bigger issue is that a record amount of people are receiving NHS App notifications to self-isolate and delays in the vaccine rollout sees cases rising, leading to widespread staff shortages. Consequently, the shortage of components is disrupting economic activity further, which may slow down the global economic recovery. 

That said, the rise of the Delta variant, while undoubtedly bad news for the world, may delay any economic tightening. A setback in contractionary monetary policy will support bonds and those sectors of the market that were less impacted by the pandemic. Thus, bad news may perversely be good news for some investors.

This odd mix of disruption and recovery makes interpreting economic figures particularly difficult. Last year, economists speculated on a U, X or V shaped recovery. Some areas, particularly in the technology sector, were boosted by the pandemic, while others were wiped out. In the recovery, some will bounce back quickly, while others will take much longer (or fail altogether). Cuts in production have led to shortages in many products, hence some industries can resume production quickly while others will take much longer. It is far from a uniform picture, which makes central bank and government decision-making even more difficult. Two weeks ago, the ECB reported its new symmetric target around 2% for inflation.  This week they put some flesh on what this means for their policy in practice. They have consistently undershot their 2% or below target for many years and, by their own figures, they will continue to do so for some time. While they see inflation this year at 1.9%, they expect it to decline to 1.4% by 2023. They said that they will not tighten until they see inflation at 2%, well ahead of their forecast horizon. In doing so, they appear to be indicating that rates will remain at or below the present level for the foreseeable future. 

With the ECB on hold, rate rises elsewhere may be constrained, as central banks may not wish to open up too much of an interest rate differential, which could see their currency rise against the Euro. The rise of the Delta variant (and, if not Delta, there will no doubt be others in the future) means that we are far from out of the woods with this pandemic. The disruption caused may take a long time to work its way out of the system. This is not good news for the world as a whole, but prolonged stimulus may continue to support many stocks. So, it is not all bad news for investors, but a selective approach will be key. 

During the summer, we may see more scares, as we saw on Monday this week, but investors should remain calm. There is plenty of money waiting to buy the dips should they occur. Remember the old adage that, in the long run, it is time in the market that counts, rather than timing the market.

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