Investment Strategies

How The Pandemic, Inflation And China Will Affect Financial Markets

Charles Paikert New York October 21, 2021

How The Pandemic, Inflation And China Will Affect Financial Markets

Putting investment returns on the table at a time when inflationary pressures - and higher interest rates from historically low levels - are a concern, is going to take more work. This news service reports on comments taken from a recent annual Charles Schwab conference.

Get ready to work harder for investment returns.

A different world on the other side of the global pandemic with less globalization and more concerns about inflation - and China - mean that asset managers will have to adjust to new realities, according to panelists at Charles Schwab’s annual Impact conference.

“The recovery has been delayed, not derailed,” said Sebastien Page, head of global multi-asset for T Rowe Price.

T Rowe is “slightly” under weighing stocks in its 60/40 portfolio, but is still convinced that the recovery has enough room to run to meet its targets, Page said.

Stock market bears, according to Page, assert that “every inch of the recovery will be taken away” as the “massive liquidity” in the market driven by unprecedented government stimulus fades and the US Federal Reserve begins to “taper” by slowing its bond purchases and reducing its quantitative easing.

Glass half full
But there’s a strong case for continuing asset gains, Page argued. The Delta variant of COVID-19 is likely to decline within six to eight months, vaccinations will increase, supply chains should improve and consumers remain “flush with cash,” with around $2 trillion sitting on the sidelines, Page said.

The global economy may be facing declining growth, but it’s “still very high growth,” he noted.

Despite a disappointing third quarter, equities are still expected to provide the “best returns,” according to Market Street Trust Company, which issued its third quarter investment review the same day as the Schwab panel.

“We continue to believe that the extraordinary amount of fiscal and monetary stimulus has created economic growth conditions that are not quite yet in the final innings,” Robert White, Market Street’s director of investments, said in the report.

Should inflation be feared?
While inflation is a top-of-mind concern for consumers and economists, both T Rowe and Market Street analysts conclude that investors may not have much to fear.

The inflation debate currently centers on whether higher prices will be transitory or persistent, Page said. He believes that inflation will “settle back higher than before” but with enough “downward pressure” from tech innovation and cheap outsourcing of consumer goods to not go off the rails.

While a growing concern for investors, inflation is “not usually a harbinger of poor equity returns,” according to Market Street’s White.

“While inflation indirectly increases the discount rate used in equity valuation models, resulting in lower stock prices, inflation also drives corporate profits higher and increases nominal consumer net worth,” he stated. “Indeed, rising wages, rocketing consumer net worth, substantial excess savings, and strong corporate pricing power, all point to the likelihood that corporate profitability and earnings will continue to surprise to the upside.”

China conundrum
China has been the other big wild card facing asset managers. Rising tensions with the US and Xi Jinping’s “Common Prosperity” policy allowing stricter government oversight of businesses to ensure a more equal distribution of wealth have clearly sent shock waves through financial markets.

But Hong Kong-based Ernest Yeung, T Rowe Price’s emerging markets equities portfolio manager, who has followed the Chinese market for 20 years, believes that the fears are overblown.

The view from Asia is calmer than the current apprehensions in Washington, Yeung said. “I don’t think China will invade Taiwan,” he said. “The tensions are not any worse than they’ve been in the last 10 years.”

He did note, however, that a Chinese attack on Taiwan would completely disrupt the world’s tech supply chain and, while unlikely, would trigger a “World War III scenario.”

The government’s reassertion of a heavy hand in business and the economy was part of an ongoing “feast or famine” cycle in China, Yeung maintained. “China has a command economy,” he said. “Regulation is always there.”

Opportunity or avoid?
In fact, China provides investors with a “compelling opportunity set,” he argued, citing the country’s goal to become carbon neutral in 20 years, which, he claimed, would take $20 trillion of investment to accomplish.

What’s more, he noted, China has over 5,000 investible companies, accounting for over 30 per cent of annual global GDP growth and is the second largest R&D spender in the world. And, Yeung predicted, regulation would ease in six months.

Market Street was less sanguine, concluding that “for the time being, it may be more rewarding [for investors] to focus elsewhere.”

China has one of the highest debt to GDP ratios of any country in the world, “much of it backed by worthless assets,” noted Michael Eisner, Market Street. “The recent Evergrande debacle, a leverage real estate company on the verge of default, is symptomatic of this situation.”

A disastrous black swan event is unlikely because the Chinese government has an iron grip on the economy, Eisner wrote. “But it gives us pause to rethink whether returns from investing in China may ultimately be attractive,” he concluded. “We believe an active approach is much more prudent, focusing on favored - by the government - segments of the economy.”

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