It’s been a challenging market environment over the last few months. It feels as though there are several weather fronts battling away, making for some unsettled conditions.

Omicron variant

Rising virus case numbers were already causing some market jitters as some European countries reintroduced forms of social distancing. Then, along came the omicron variant, dealing a blow to markets in the final days of November.

Uncertainty was rife with the main concern being that potential vaccine evasion would send us back to the drawing board. This initial sentiment was quickly displaced by the realisation we have a wide array of treatments and tools at our disposal today, including a lot of practical experience of how to live with the virus.

This helped to reduce the uncertainty and investors remain focused on the favourable long-term outlook.

Inflation is back

Inflation has been a focus point for markets for the best part of a year. With inflation in the US rising to 6.8% in November and the UK soaring to a 10-year high of 5.1%. It’s no wonder that many investors are getting nervous.

Our base case has always been that we could emerge in an environment of higher inflation whence we came. The most significant contributions to inflation continue to come from sources we think can’t sustain price rises forever, such as car purchases. At some point, demand for a new family car becomes saturated (whether it’s brand new or second hand) and eventually, the production and supply of new cars will normalise.

Energy costs are the other significant driver. But, as with various points in history, energy cost inflation is unlikely to be sustained for long.

Supply constraints

Many businesses have complained of constrained supply chains, especially the auto sector where we’re familiar with production declines of 40% or more. Generally, the problem is not with supply, more that we have seen an explosion in demand.

The global value of goods supplied is at record highs, including in the semiconductor industry that has taken much of the flack for causing bottlenecks. The impact of lockdowns was to reshape global spending patterns. We saw a collapse in spending on experiences – meals out, trips to the cinema & holidays, and a rise in spending on products – like cars, computers & webcams.

It is only over the last couple of months that the ‘shape’ of economic activity has started to return towards (but has not yet reached) pre-pandemic activity. This is helping to normalise the demand for goods. This should help ease supply chain bottlenecks over the coming months.

China’s tech crackdown

China has introduced a slew of new tech regulation, resulting in substantial losses for investors. We’re not expecting this sector to return to favour in the near term, although we are monitoring it closely. If for no other reason, China’s sheer scale makes it an investment market that is hard to ignore.

It appears that western geopolitical machinations are aiming to hamper the growth of China which is widely seen as a threat to national security. This threat comes from substantial cultural differences, and genuine competition.

China is no longer the factory to the world. They have developed world class expertise in many of the industries of the future, including artificial intelligence (Alibaba is equivalent to Amazon; Tencent is equivalent to Facebook; Baidu is equivalent to Google; Xiaomi is equivalent to Apple), autonomous vehicles (Baidu’s robo taxis’ already drive passengers around five Chinese cities and generated $5billion in revenue in the third quarter of this year alone), amongst others.

Looking forward

Changes in any of these factors, as well as others, could easily cause serious deviations in market sentiment.

For now, our expectations remain unchanged. We believe the economic rebound from reopening is largely complete. In our view, we should continue seeing growth, albeit at a moderated pace.

This means we’re still confident in our exposure to markets. In recognition of the rising risk of a higher inflationary environment, we have been paring back our exposure to the most sensitive parts of markets whilst focusing on companies with strong pricing power, which should fare better.

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