Is an equity market correction overdue? The US Federal Reserve takes one step closer to tapering its bond purchases and Irish timber prices hit record highs. All these stories and more are covered in this week’s insights update from BlackBee.
The publication of minutes from US Federal Reserve meetings isn’t normally a market moving event for investors, but last week it was. The minutes gave a further signal that the US central bank was on the cusp of reducing its $120 Billion of bond purchases per month, the opening salvo in tightening monetary policy. The selloff in risk assets following this news was the clearest confirmation (if any was needed) that zero interest rates and Quantitative Easing have been central planks of the market recovery since March 2020.
For our part we believe the taper and other aspects of the return to ‘normal’ monetary policies will be very gradual so as to avoid destabilising markets. But the reversal of these policies in the next couple of years will be a fairly stiff headwind for markets to contend with. We believe that markets can climb higher over the medium term, but these gains will have to come thanks to an improving economy and market fundamentals. So gains are likely to be more of the ‘grinding’ variety rather than the supercharged returns witnessed since the market’s pandemic lows.
Could the Fed’s taper cause equity markets to correct (i.e. fall by 10% or more)? If handled badly we believe it could but so too could other factors (the realisation that higher inflation is becoming more permanent or the COVID delta variant dragging the economic recovery down). It’s impossible to predict if a correction is going to happen in the short term. However even in equity bull markets they occur quite regularly (our Chart of the Week this week shows a correction around every 18 months since 2010) and almost 18 months into this recovery we may be getting to the point where one is overdue.
As mentioned above equity market sentiment was hurt last week by the minutes of the US Fed’s July monetary policy meeting with equity markets in most regions hit over the week. However, other factors also played a part. A weaker than expected US July retail sales report created some nervousness that the economic recovery may be beginning to flag. US economic data has underperformed expectations in the past few weeks although we’re still very much of the view that the economic recovery globally should continue. The fall of Kabul to the Taliban also hit bullishness while the ongoing crackdown on the technology sector by the Chinese government badly affected tech heavy indices in Asia with the Hang Seng actually entering into bear market territory, moving 20% down from its February peak.
With the negative backdrop for equities and risk assets generally, it was no surprise that bonds enjoyed a better week. Sovereign yields moved modestly lower over the period with economic and geopolitical concerns trumping the talk of the Fed taper, leading to positive returns for government bond indices. Riskier sectors of the bond market like corporate bonds and emerging market bonds actually fared reasonably well over the week all things considered with investors perhaps looking a little more positively on them following their weaker performance over the past few weeks.
Coming into last week one would have felt that the geopolitical crisis in Afghanistan would have been enough to put a further bid under both oil and gold. Not so however as both took their cue from falling risk assets; oil badly hurt by the risk of deteriorating economic data (copper too felt the brunt of this) while gold shuddered at the prospect of the news on the Fed taper and the growing realisation of tighter monetary policy over the next couple of years.
Forestry – Demand, licensing backlogs drive Irish timber prices to record highs
Last week the Farmers Journal reported that Irish timber prices had reached new record highs with prices for high grade logs reaching double the levels that prevailed back in 2017. The reopening of the construction sector has been a factor behind the growth in prices although so too has the low numbers of felling licenses that have been issued over the past year, something which has forced sawmills to import increasing volumes of timber from abroad. In our view it is vital the licensing regime is reformed as soon as possible not only to allow a smooth flow of timber to the Irish sawmill and construction industries, but to also ensure that Ireland’s medium term afforestation targets can be met.
Hospitality – Global hotel activity on the rise, regional trends mirroring the economic recovery
Last week Jones Lang Lasalle (JLL) published its latest global hotel survey which showed that investment activity in the sector was undergoing a fast recovery. Investment activity in the first half of 2021 reached $30 Billion, 66% up on last year but interestingly only 4% lower than the previous peak in the first half of 2019. So far though the recovery in investment spend is mirroring the global economic recovery insofar that it has been heavily focused thus far in the US where vaccination rates are highest, and restrictions have been rolled back significantly. Key factors investors cited as those that might entice them to purchase were vaccine penetration and improving occupancy rates with Europe representing one of the more attractive regions for investment over the next twelve months.