George Lagarias, chief economist at Mazars, on three things for investors to watch this week
- Markets are soaring despite evidence of wage inflation, a hawkish Fed , a rampant Delta variant, the Chinese crackdown on tech giants and wildfires across Europe. The main reason for this is an exceptionally good earnings season which has seen 87% of companies beat revenue and earnings expectations.
- The situation leaves the Fed torn. Inflation and strong job growth should prompt tightening. Fears over the course of the pandemic may pause thoughts of tightening.
- With such low visibility, any decision carries an abnormal amount of risk for an organisation too used to defining its environment.
“Last week saw a negative body of evidence amassing against present market euphoria. A very good jobs report in the US wrought worries that the Federal Reserve might ‘taper’ (reduce) quantitative easing after September. Meanwhile, the Delta variant’s spread has pushed back a lot of return-to-office plans and continues to put strains on both the recovery and supply chains. In China, the crackdown on tech giants persists with little concern as to how these moves will affect western consumers. And in Europe the consequences of climate change are becoming all too real with the hottest summer in thirty years causing massive wildfires and loss of life and property all across Spain, Italy, Greece, Cyprus, Turkey and Ukraine.
“To explain the complete market apathy on current events (the S&P 500 is near all-time highs at 4.430 points), one has to remember that fundamentally, stock market investing is about confidence in future corporate earnings. The current earnings season is seeing an 88% rise in profits and an 87% of top and bottom-line announcements beating expectations.
“But don’t geopolitics affect future earnings? The truth of the matter is that asset allocators have always been cautious with the Chinese brand of capitalism, which is why they habitually ignored the breakneck pace of growth and continued to treat the world’s second largest economy as an ‘Emerging Market’. And as for climate change, realistically the game of ‘following the investment money’, outweighs concerns as to whether the Paris accord’s emission targets are realistic any more, or whether reducing massive global fossil fuel subsidies is even an attainable goal.
“Which leave us with the tug-of-war between the Fed’s quantitative easing, the economic recovery, inflation and the ‘Delta x-factor’. On the one hand, the Federal Reserve sees potential for a persistent recovery and labour shortages as evidence of demand-inflation and cause to contemplate asset purchase reductions. On the other, the ‘Delta’ variant is not only pushing back plans for return to normality, but it is reminding us that new and more threatening variants could follow, which could topple the economic recovery altogether.
“Fed economists may be trained to stay ahead of economic developments, but they have to accept that as long as the virus drives the global economy, they will be making decisions in the dark. With such low visibility, any decision carries an abnormal amount of risk for an organisation too used to defining its environment. Raise rates and risk a serious policy error if the pandemic persists. Persist with accommodation and risk remaining too far behind the inflation curve.
“Investors should not fight the Fed. But they should also not attribute super-human abilities to its decision making either.”
