Covid mutations, the rate of inflation and global growth rate are three things Charlotte Yonge, assistant manager of the Trojan fund and manager of the Trojan Ethical fund, has said markets are misinterpreting at the moment.
When the news about Omicron as a variant of concern emerged a few weeks ago markets immediately sold as investors anticipated more intense Covid restrictions and sought out ‘safe haven’ assets for protection. For example the FTSE 100 fell 3.6% when markets reopened the day after the news emerged and the S&P 500 was down 2.3%.
Yonge said she was “not surprised” by the sell-off because “markets were so complacent coming into this quite predictable evolution of the virus”.
She said that even with a strong vaccine rollout – in some countries – viruses mutate, despite the best efforts to prevent this inevitability.
“And that was has been very much at odds with markets appreciating in line with a very blue sky scenario for a seamless recovery,” Yonge said.
Equities rerated in the summer in line with easing lockdown restrictions as many managers spoke about Covid being in the rear-view mirror. But Troy took a different approach, reducing the equity exposure in both the Trojan and Trojan Ethical fund by 40% because the valuations had gotten “uncomfortably high”.
When the Omicron variant was announced and markets corrected it served as a reminder that “this is going to be a lot less straightforward than what is currently being priced in,” Yonge said.
Another element markets are overestimating is the global structural growth rate long-term, which Yonge said is unlikely to be as high as investors are pricing in.
She said that while a lot has changed during the pandemic the global growth rate has not structurally increased.
“We’ve still got the same demographics that we had pre-Covid,” Yonge said, “and our economies are still highly indebted, even more so now.”
In the short-term structural growth is building at a high rate she said, but equities are being priced as if this is going to persist and still have a long recovery ahead of them.
“Before the pandemic structural growth was already slowing and, if anything, that actually risks continuing now,” Yonge said.
Coming into March 2020 Yonge said that markets were already “pretty close” to the end of the economic cycle “and what’s to say that we’re now suddenly at the beginning without having a reset?”
She said at the end of a market cycle there is usually a period of recession and bankruptcies, but Covid prevented that from happening because companies received a huge amount of government support that kept them afloat.
“There wasn’t a ‘clearing out’ phase of the economy that normally happens at the end of the cycle. So I think equity prices are not reflecting that risk to growth,” Yonge said.
The third thing being misjudging by investors is that inflation will persist at its current levels long-term.
Inflation in the UK is currently at a 10-year high after hitting 4.2% in October. In the US it is even higher at 6.2% but Yonge said she would be “very surprised” if these levels were sustained. “And those levels are not factored into investment bond prices, especially in the US” she said.
US index bonds are pricing inflation at 2.5% per annum for the next 10 years, just above the Federal Reserves’ 2% target.
“We actually think there's inflation protection there, which is quite well priced, particularly versus the UK,” Yonge said.
The recent events of supply chain issues, increased demand and slow labour growth have created a lot of distraction about what the sustainable rate of inflation is actually going to be.
But there are some large countervailing forces having an impact, Yonge said, like the increased fiscal support and the ability for companies to hire people from almost anywhere in the world now due to digitalisation, which is changing the labour supply. “This is likely to have a deflationary impact long-term,” Yonge said.
The manager added that she is less worried about these short-term “permutations” regarding inflation because they are “very unique and potentially, temporary factors” that mask some of the bigger changes going on.