The return on LD Discretionary, the largest investment fund within The Cost-of-Living Allowance Fund, stood at 7.6% on 13 December 2021. The return over the last 36 months stands at 17.4%. The fourth quarter of the year has seen greater volatility than the stock markets experienced for most of 2021. The overarching themes in the markets during this period have been inflationary pressures, central bank policy and a new variant of Covid-19.
A strong US economy
From a macroeconomic perspective, the economies of both the US and the eurozone appear to be in good shape. US employment has gradually improved, and unemployment fell to 4.5% in November, which is very low by historical standards. Retail trade in the US is also performing well, whilst the industrial and manufacturing sectors are growing. Leading indicators for the US economy therefore point to robust growth over the next few months.
In Europe, the growth picture has also been positive over the past few months. Both the services sector and the labour market in Germany, France and Spain have contributed to GDP growth of 2.2% in the third quarter of 2021. However, leading indicators for the eurozone have been on a downward trend in October and November. The IFO index, which reflects business leaders’ expectations for growth in the coming months, has fallen significantly since the summer, with expectations for the services sector in particular declining.
Continued pent-up demand from consumers and businesses, combined with shortages of materials and goods as a result of Covid-19, is contributing to higher inflation. The US Consumer Price Index rose by 0.9% in October and by 6.2% year-on-year. This is far higher than expected.
In terms of monetary policy, the response to rising inflation differs between the US and the eurozone. Both the US (Fed) and European (ECB) central banks have stated throughout the year that inflation is temporary and is due to supply bottlenecks caused by the Covid-19 lockdowns, which will subside without intervention. In the US, President Joe Biden has reappointed Federal Reserve Chair Jerome Powell. Powell has indicated that a shift is needed away from the extremely accommodative monetary policy. Now that both growth and inflation have returned, the view is that there is no longer a need to purchase $130 billion worth of bonds every month. The Fed therefore decided to scale back purchases by $15 billion per month, starting in mid-November 2021. This means the bond-buying programme will be completed by June 2022. Following this, the financial markets expect the Fed to raise interest rates in 2022 and 2023.
Unlike the Fed, the ECB remains reluctant to tighten monetary policy. Christine Lagarde, President of the ECB, has stated that the current price pressures will subside of their own accord.
Omicron variant causes fluctuations
Covid-19 infection rates have been rising throughout November, but did not initially give cause for concern. However, this changed when a new variant, Omicron, was detected in South Africa on 26 November 2021. It may prove to be more contagious than previous variants. However, it is still too early to draw too many conclusions. The combination of central banks phasing out their asset purchase programmes and uncertainty surrounding the new Omicron variant has caused volatility in the markets. Despite the fact that knowledge of the Omicron variant remains limited, much of the stock market trading has been driven by uncertainty over what it means for vaccine effectiveness and further restrictions over the winter.
November 2021 therefore ended with a negative return following a two-week period in which share prices fell by 5%. On 26 November alone, global equity markets fell by 3.5%. Year-to-date, however, the equity market has delivered a return of 24.4%, and by early December, equities had already recouped some of their losses.
Yields on government bonds fell in November, and the US dollar rose. High-yield bonds have fallen in price. Oil prices fell sharply due to concerns about global demand. Over a two-week period in November, 10-year government bond yields fell by 32 basis points. The 2-year US yield rose from 0.5% to 0.57% over almost the same period. The German 10-year yield fell from -0.09% to -0.34%. The Italian 10-year yield fell from 1.13% to 0.98%. The downward trend in the markets was also reflected in bond market returns. Investment-grade bonds yielded returns close to zero. US and European high-yield bonds fell by -1 per cent and -0.6 per cent respectively in November.
Overall, there is still scope for further economic growth. This is particularly true of the services sector in the US, which accounts for 70 per cent of total economic activity. Furthermore, the labour market is strong and demand for goods and services is high in both the US and Europe. Uncertainty surrounding the new Covid variant, Omicron, may cause volatility in the stock markets, as relatively limited information remains available. We are therefore likely to see strong reactions in the financial markets whenever either positive or negative news emerges. For example, the market is likely to react positively if the extremely accommodative monetary and fiscal policies are extended as a result of the growing uncertainty surrounding the new virus variant.
