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Five insights in five minutes

Five in Five: gas, China, equity cycles, Europe inflation, MA and alts
08 October 2021

    Energy prices

    Wholesale gas prices in Europe have doubled since mid-August, oil everywhere is a fifth more expensive and coal futures are up 50 per cent. British pumps are dry for other reasons, but Indian electricity plants struggle to find coal while many Chinese provinces have endured power shortages. It feels bad out there. Investors, meanwhile, fret about implications for inflation and growth. But this is not an energy crisis, says our strategy team. For starters it’s a gas issue, mostly. Crude prices are barely above where they were in June. And the pain in Europe (for myriad reasons including low inventories, no wind, hot summer in Asia, rebounding demand, expensive carbon credits, drought in Latin America, fire at a Norwegian LNG plant) is not being felt in America, the world’s second bigger gas producer behind Russia – as can be seen below. One story to watch is that traditional oil and gas stocks have now jumped by third over the past twelve months, whereas global clean energy indices are flat, having slumped 50 per cent since January. Time to look at renewables again for those who missed the green boat first time?

    Ways to play: Climate change funds, low carbon, ESG

    Energy prices  

    China growth

    Mao Zedong once said, “many hands make light work”. But at a current labour force of 800 million people, this is probably as many hands as China will ever have. Does a slowly declining number of breadwinners pose a challenge to the country’s economic trajectory? The chart below, which breaks down Chinese economic growth into its three fundamental drivers (taken from our China Insights publication this month) suggests otherwise. As you can see, Labour force expansion’s impact as a growth factor has been negligible since the 1990s. What have mattered much more are capital accumulation and productivity changes, which account for 70 per cent and a quarter of growth respectfully in the past three decades. But as the experience of the four Asian Tigers tells us, continuously piling up capital isn’t the key to perpetual economic expansion. The answer to sustained growth for an advanced economy is rising productivity. Encouragingly for investors, Beijing understands that the country is near the end of the old model, and is therefore looking to switch from hands to ‘quality growth’ driven by technological innovation.

    Ways to play: China equities, China bonds

    China growth  

    Equities, bonds and jobs

    With share prices generally mirroring the northern hemisphere’s weather of late, the recent cooling off has left the global MSCI index five per cent below last month’s highs. Yet history suggests that you should not swap your equity sheets for an electric blanket of bonds as winter approaches. Our strategists have generated a chart showing periods of equity outperformance versus bonds over the past three decades. As you can see, when America’s unemployment rate is falling, as it is today, stocks have consistently outperformed. The International Monetary Fund’s World Economic Outlook projects US unemployment to continue to decline through 2023. Of course, stock market returns have outpaced the improvement in jobs so far this cycle, giving rise to claims of frothy valuations. Nonetheless, bonds are hardly cheap either, and with interest rates barely out of a long freeze, it would be brave to expect the historical relationship below to end soon.

    Ways to play: Multi-asset, global equities, fixed income

    Equities, bonds and jobs  

    Europe price pressures

    In true new-age fashion, the German ministry took to Twitter on Monday in an attempt to quell inflationary concerns as consumer price rises hit the highest in three decades at 4.1 per cent in September. The numbers for the eurozone aren’t much lower. Inflation across the continent increased to 3.4 per cent in September, up from three per cent the month before – a record since 2008. Even back in August, higher gas and electricity prices were already adding 50 basis points to headline inflation, and considering these feed through to consumer prices with a lag, figures could increase further and stay elevated through early 2022. For perspective though, even if wholesale gas prices stay at €60 per megawatt hour until next March, where they were as recently as mid-September, European inflation would peak at around 3.5 per cent in the fourth quarter of 2021, about where it is now. And the ECB’s own projections for 2023 show both headline and core inflation averaging a below-target 1.5 per cent. The transitory narrative remains – at least for now.

    Ways to play: Europe equities and fixed income
    Europe price pressures  

    Multi-asset and alts

    There’s an old joke from the 1970’s where a school maths teacher asks a streetwise young student: “Jonny, what’s five per cent?” To which he replies: “Exactly, what’s five per cent?” These days, with interest rates miles below those heady times, generating even that number is harder than algebra. Indeed, our strategists’ expected returns modelling spits out just 3.6 per cent before inflation for a traditional 60/40 allocation. That’s way beneath historical levels and what most investors expect from a diversified portfolio. One option is to inject alternatives into the mix (including illiquid assets). Calibrating the model, let’s assume a five per cent return objective. The output is a portfolio with half in alternatives, as can be seen below, a third of which is private markets. Such an allocation wouldn’t be for everyone. But it demonstrates that thinking beyond traditional asset classes can push expected returns to the front of the class.

    Ways to play: Private equity, venture capital, hedge funds, private debt, real estate

    Multi-asset and alts  


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