We’re either slowing sharply as shortages hinder economic activity or, if not, central banks and governments will take away the punch bowl, removing a key supporting factor for financial markets.
We’ve now moved past the peak in growth as the boost from reopening is behind us and policy stimulus, while still supportive, becomes less intense. But we’re also moving past Covid-19 and so the level of activity should continue to rise as spare capacity is reabsorbed. We think we will move past peak inflation in 2022, partly because supply is expanding and partly as pent-up demand is now spent. With cyclical acceleration no longer the dominant driver, financial markets may be less well supported in the near term. But with economic expansion continuing and policy remaining easy on the whole, the riskier asset classes such as equities and credit should still outperform safer bonds.
To cushion the fallout from Covid-19, central banks deployed unprecedented policy support to cap borrowing costs so governments could spend aggressively. Core sovereign bond yields, which had already been on a secular downtrend, fell further in response to lower policy rates and scaled-up asset purchases. As the world economy recovers more visibly and job creation gradually comes back, central banks are now tapering their asset purchases. The next step is rate hikes. We believe this will happen in a more gradual fashion than market prices suggest. We may be about to see higher, but by no means high, bond yields, as they’re starting to rise from record-low levels. As this happens unevenly across countries and regions, currency markets could become more volatile.
We frame any investment in risk-adjusted terms. There’s some extra risk to consider when looking at emerging markets relative to comparable opportunities in developed markets. They include environmental, social and governance (ESG) factors, but also geopolitical issues, especially when it comes to the credibility of promises to address some of these factors. But an economy and capital market as large as China is critical for understanding the global cycle. We think China’s transition promises to create an institutional and regulatory infrastructure to prioritise long-term development, also in terms of achieving its‘net zero’ ambitions, rather than short-term growth. This may present investment angles and market perspectives worth exploring.
Our planet is our home – and it’s the only one we have. Spending on infrastructure looks set to rise. Some of the projects are physical – roads, bridges, railroads and other public projects. Others are in green and digital areas. Policymakers are aware of climate change and the need to support human capital, which suggests to us that the effort to make infrastructure more sustainable is structural. This shift from emergency fiscal support to outright public investment, plus regulatory and sustainability considerations, is likely to be important for other sectors too. The segments of the real estate market that can flexibly adapt to these structural changes may benefit, along with logistics and warehousing.
While we agree that choosing the right sectors and companies is key, and for that we think a bottom-up approach like ours is crucial, we also think three key top-down trends are gaining momentum, turbocharged by the pandemic. First, rising R&D spending, especially in disruptive technologies. Second, expanding capital investment, in particular in intellectual property, greener solutions and infrastructure. Third, faster productivity spreading across countries and sectors. We expect public and private firms, as well as investment themes at the intersection of all this innovation, to benefit from these drivers. We regard this as a structural trend spanning many years.
Improvements in higher productivity segments supported by automation, digitalisation, artificial- intelligence (AI), e-commerce and remote computing worldwide have the potential to boost overall growth.
This should continue to support job creation for non-routine cognitive roles and tasks. A key factor will be the rising importance of intangible assets. Some intangibles are included in statistics, such as software, data, R&D and content. Many aren’t, such as brands, marketing, design, financial innovation and networks.
Financed by private investments and fiscal programmes, in particular in the US, many sectors should benefit from accelerated digitalisation trends that have been fast-tracked by the pandemic. They include videoconferencing, consumers shifting to e-commerce, digital payments and the ‘internet of things’. AI is displaying progress in many fields, from natural-language recognition and driverless vehicles to broadening the areas of use of the ‘messenger RNA’ approach behind some of the Covid-19 vaccines.
Technological innovation should drive the generation and diffusion of new ideas. While resulting productivity gains may be hard to see at first, they could generate faster structural growth and continue to change the way goods and services are produced and how we consume them.
Since the mid-1990s, R&D spending has been driven by private investment. Now public R&D spending is finally stabilising and even rising again in some countries.
Faster capital accumulation is driving physical and digital capital expenditure, boosting many areas like automation, with the use of robots spreading in factories and warehouses at an increasingly rapid pace.