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CIO 2021 reflection – COVID-19, inflation and fiscal stimulus

07 January 2022

Looking back at 2021, investment markets have been dominated by three interlinked factors: the ongoing pandemic, the steep rise in inflation and the potential withdrawal of central bank stimulus and interest rate rises. All these factors could have damaged the prospects for equity markets, and yet in December many indices reached new highs.


Jonathan Marriott, Chief Investment Officer

The ongoing pandemic

The year had opened on an optimistic note, with the vaccine roll-out bringing hope for an end to the pandemic. Unfortunately, this was met with the spread of both the Delta and subsequently the Omicron variants, reminding us that the pandemic is far from over. Omicron, in particular, brought with it more restrictions. While apparently less dangerous, it is more infectious. Thus far, the spread has been dramatic and is putting pressure on health services. Given that most people are now set up for home working, the impact of the latest restrictions has been easier to manage in the short term. Despite an initial dip following the announcement of the new variant, markets have chosen to look through these developments to better times ahead.


Inflation has risen dramatically, and the debate has been about how transitory this is. The increase is partly due to a recovery in prices from the depressed levels of 2020. There have been shortages of supply due to the pandemic, which was not helped by the Suez Canal blockage earlier in the year. With containers in the wrong place, shipping costs between Asia and the West have soared. The shortage of gas has seen energy costs rise steeply. In the UK, the full force of this will not be felt until the first half of the new year. As a result, in the UK, we are likely to see even higher annual inflation numbers in the coming months. However, there are signs of some commodity prices easing off their highs and, while we started last year with low base costs, the reverse may be true this year, easing inflationary pressures. While the fears are that inflation is more persistent, we expect that the rate should eventually ease back towards the central banks’ 2% target as many of the price rises in 2021 are not repeated.

Central bank stimulus and interest rate rises

Rising inflation put pressure on central banks to tighten monetary conditions. In the UK, we have already seen a small rate rise. Elsewhere, the bond purchase programmes put in place to support the economy are being reduced or coming to an end. This has been priced in with bonds selling off. However, with the surge of the Omicron variant and the fear that rising rates risk a fresh recession, longer dated bonds, particularly in the US, held up in the fourth quarter. Having priced in rate rises, we see some value in US shorter dated bonds for those looking to balance equity risk in portfolios.

Equity markets came through the scares of the last year to focus on a post-pandemic recovery. The debate within equity markets at the start of 2021 was value versus growth, with value strongly outperforming. By the end of the year, growth had caught up and, based on the US Russell indices, was slightly ahead. However, this debate disguises a concentration of return with some huge tech names particularly strong. Only a short time ago Apple was the first trillion-dollar company, today it is flirting with market capitalisation of $3 trillion. The dispersion of returns has been high and we expect it to remain so in the year to come.

Challenges will remain as central banks move towards withdrawing the pandemic support and look to raise rates. Higher prices are in themselves a constraint on consumer spending. This, combined with interest rate rises and potential tax increases, may constrain economic growth after the recovery from the pandemic. As a result, we expect eventual interest rate rises to be moderate and less than the market has priced in. Overall, this will support selective equity exposure but we retain a preference for companies that have pricing power and can pass on any rise in input costs. As long as COVID-19 vaccination rates remain low in many parts of the world, new variants are likely to emerge, which will no doubt add volatility to markets. As 2021 demonstrated, it may be best to look through these short-term developments and focus on long-term returns.


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