Over recent weeks, financial markets have become more volatile and both sovereign bonds and equities have pulled back from recent highs, although stocks have delivered solid returns year-to-date and credit markets are steady.

Markets are concerned about a number of issues including slowing global growth, a whiff of stagflation, the prospect of the US Federal reserve tapering and a major crackdown in China on the over-leveraged property sector and other industries that appear to threaten national security, state control and the policy of “fairness for all”.  In addition, natural gas prices have soared in Europe at the same time as a severe power shortage has shut down a big chunk of China’s manufacturing activity, with both events further weighing on economic growth. We remain optimistic on the longer-term outlook but expect this volatility and uncertainty to persist for the next few weeks as we await more clarity on the outlook for global growth, inflation, China and US fiscal policy.

It is clear from a range of data such as industrial production, retail sales, global trade, and a variety of business surveys that the pace of the global economic recovery has slowed in recent months. To some extent, this growth moderation is simply reflecting a natural normalisation of activity as the effects of past stimulus fades, output approaches or exceeds pre-virus levels and as demand reverts to more normal measures. Given an ageing demographic, high debt levels and a huge surplus of excess global savings, it is likely that real (after inflation) economic activity will shift lower to its pre-pandemic trends, unless the current economic policies being pursued result in significantly higher productivity.

However, it is also evident that consumer caution has returned in some areas, especially where the number of virus cases has increased. In addition, there is increasing evidence that widespread shortages of goods and labour together with rising costs are limiting growth. China has added to these growth fears as it seeks to press ahead with reforms aimed at furthering Xi Jinping’s political goals which include tightening the regulation of internet platforms. At the same time, with the US already slowing, the economy is facing further potential headwinds from higher bond yields, a stronger dollar, rising energy prices and political stalemate.

On the whole there are reasons to remain optimistic on the longer-term outlook for stocks and bonds. Global policy makers have little choice other than to pursue reflationary policies and that should ensure that equities continue to benefit from plentiful liquidity, reasonable growth, supportive monetary and fiscal policies and stretched but not extreme valuations.

For now, fund managers seem to be staying reasonably defensively positioned but expect markets to eventually to overcome these worries and continue to climb.

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