Portfolio Adviser • Portfolio Adviser Magazine December 2021 • Counterpoint

With real yields anchored at historic lows around -100 basis points, there is a disconnect between the bond market and the real economy.

In the face of growing economic activity, albeit at a slower pace, and elevated inflation expectations, we see the potential for yields to move higher.

While the rate of economic expansion has peaked, it must be remembered that activity is slowing from an unsustainably high base. The sharp rebound in economic activity was driven by extraordinary stimulus and now activity is slowing because stimulus has faded.

It is also worth bearing in mind that activity in the services sector is yet to fully normalise and manufacturing activity may be impacted by supply constraints evidenced by most industries reporting record-low inventories.

For next year, our base case remains that the strength of household balance sheets can support the cycle in the near term.

Personal incomes in the US are 4% above pre-Covid levels, excluding stimulus, and wages are 7% higher. Household consumption is up 7%, even though spending in services has only caught up to pre-Covid levels.

Excess savings from stimulus and underspending is about $2.7trn (£2.03trn), or almost 17% of current household spending. This is material firepower that can be deployed to prevent a hard landing.

Turning east, China is slowing at a faster pace relative to the west, with activity showing the first signs of contraction.

China emerged from Covid-19 stronger than western economies and used the rebound to tighten policy and accelerate regulatory reform.

There is no question Chinese regulators have acted in a blunt fashion, but recent policies, particularly around anti- competitive behaviour and data security, are relatively rational and consistent with policies elsewhere in the world.

Policymakers in China appreciate that accelerating the transition to a consumption and services-driven economy will require a vibrant private sector.

It also requires household spending to grow at a faster pace than incomes. China’s extraordinarily high gross savings rate – nearly 45% of disposable income, more than double that of the western world – needs to be run down.

The broad goal of policymakers is to incentivise consumption over savings by improving the social safety net via a ordable housing, education and healthcare.

Staying in China, it is important that we remember China and the US are at extremely di erent points in their economic cycles.

China is slowing but has a material monetary and fiscal toolkit to stimulate, while the US – and western economies more broadly – are past the peak rate of stimulus.

With Chinese government debt less than 70% of GDP there’s significant fiscal fire-power to o set a slowdown from the property sector.

We expect fiscal stimulus will focus on consumption, reinforcing the social safety net and enabling the country’s decarbonisation goals.

While China is set to loosen, having achieved reform along the way, the Federal Reserve is embarking on tapering against a backdrop of slowing activity and higher inflation.

Even though the Fed maintains that rising inflation is transient, our analysis suggests core inflation in the US will not peak until the end of next year.

Pandemic-related pressures will begin to subside as economies reopen and supply chains normalise, but this can be o - set by pent-up wage pressures and rents, and now rising energy prices.

Wages are currently rising at 5% per annum versus pre- Covid levels, compared with 3% per annum historically, and this is despite the current slack in the labour market.

Some 4.3 million private sector workers are yet to find jobs relative to pre-Covid, the majority in the services sector. Additionally, house prices in the US are accelerating at the fastest pace in 15 years, which feeds into rents with a lag.

Our longer-term view remains that global policymakers will be reluctant to shift to austerity too quickly and that attitudes towards fiscal stimulus have undergone a fundamental shift.

Investment cycles around decarbonisation, the adoption of 5G, infrastructure, catch-up spending within the health system and a capex cycle around the unbundling of global supply chains can lead to a change of direction away from viewing the world as a permanently low growth, lowrate environment.

There will be low multiple stocks that can transition to secular growth winners, and this can further fuel the rotation in equity preferences.

New investment cycles can also tighten the extreme valuation dispersion between US equities and the rest of the world. US equities are valued at a 65% premium, despite very similar earnings growth through time.

This premium has been driven by outsized stimulus in the US and exposure to secular trends around software and the internet, given the US is home to large-cap tech – but it is unlikely to be sustainable.

Emerging investment cycles benefit companies globally and the rest of the world is not being priced for success. Indeed, the global benchmark – with a 60% exposure to US equities – is unlikely to reflect the best opportunities.