Getting the economy back to cruising speed after tale of two halves in 2021

As we close the final chapter of 2021, it’s important to acknowledge how far we have come since last year. Armed with vaccines and viable Covid-19 treatments, the global economy is learning to live with the pandemic, in the same way that investors are learning to invest with it.

We can summarise the year as a tale of two halves. The close of 2020 saw the first Covid-19 vaccines announced as economists began to predict the shape of the recovery. The first half therefore was all about growth, with some record quarterly numbers reported. The UK experienced a flash recovery in the second quarter, where the recovery amounted to more than 20 per cent compared to the year before. Corporate earnings mirrored this with record-setting numbers.

The second half, however, saw the world quickly enter a “mid-cycle” slowdown despite the end of furlough in the UK and a slew of enhanced unemployment benefits in the US. Higher prices from supply-side disruptions weighed on the level of consumption growth seen in the first half. That said, productivity gains, a healthy pipeline of fiscal spending, and climate-driven investment should help post-pandemic growth rates.

As we look ahead to 2022, we believe the way in which the world’s major central banks withdraw emergency measures is key to supporting the recovery momentum; it needs to be careful, measured and data dependent. Together with the removal of government support, this should lead to a more self-sustaining model with a good chance of succeeding if coupled with a return of demand in those sectors most affected by the pandemic.

However, disruptions in supply chains, divergences between businesses that benefitted from the pandemic versus those that suffered, the same for developed versus emerging markets, and red-hot asset valuations in some areas must be resolved if we are to succeed at getting the economy back to cruising speed.

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We expect capital expenditure to be supportive as productivity gains and low financing costs encourage investment. Inventory restocking will keep end demand alive, and the activation of pent-up demand will underpin consumption.

Whilst inflation remains high, the extraordinary nature of the Covid-19 recession has affected supply and demand in a way that makes it very difficult to separate temporary from more persistent inflationary forces. Overall, we think the drivers of price increases are short-term. We predict that prices will not continue to rise as steeply as they did in 2021 but will also not go back to the pre-pandemic low levels, meaning that should slow but not disappear. Over the past decade, asset prices have become a larger determinant of economic growth compared to consumer prices. It is therefore crucial that policy-makers deliberate financial market impacts as they begin to retire monetary and fiscal support.

So where does that leave us as far as positioning is concerned? We remain constructive on equities as an asset class because they protect against inflation and look good value relative to cash and bonds. Post-pandemic spending on energy transition technology, digitisation, media and advertising, biotechnology and advanced medical care position technology and healthcare companies as likely to outgrow the economy.

Energy transition technology will benefit from the world’s net-zero carbon emissions goals. “Electrification of everything” has begun and new technologies are satisfying our growing energy needs and reducing dependency on fossil fuels. As well as technology and healthcare, we also favour financial companies as they provide a portfolio hedge for potentially higher interest rates and a tightening liquidity environment. From a regional perspective, this preference for defensive growth favours US and Swiss equities, which are abundant with well-managed and high-quality businesses.

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As we enter the stage where central banks think about tightening monetary policy, fixed income as an asset class has been less effective in dampening portfolio volatility. In real terms, the cost of adding protection against the next recession by buying 10-year US Treasuries or UK Gilts is approximately 1% and 3% per annum respectively. Within high-yield credit and emerging market debt, we believe active management and selectivity are key. When central banks withdraw liquidity and governments end pandemic support, “zombie” companies could potentially prove worrisome in the race for yield.

Finally, as the world grapples with Omicron, we remain watchful of how central banks respond to a potential economic slowdown, just as monetary policies begin to normalize. Ultimately, we view strategic asset allocation, active management and disciplined diversification as key to navigating this uncertain outlook.

Stuart Paterson is executive director at Julius Baer International Limited

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