Squeezing the cycle
The coronavirus pandemic, as devastating as it has been, brought about a faster and bigger monetary and fiscal response than in any previous recession. This response limited the damage to the economic system and set the stage for one of the fastest economic recoveries in decades, coupled with double-digit equity returns globally. However, the downside of the unprecedented economic stimulus is that demand has bounced back much faster than supply, causing inflation to rise more rapidly than in previous cycles. As a result, the global bond market suffered its worst year in over twenty years.
To produce reliable income and more predictable investment outcomes, Marriott invests exclusively in high-quality, dividend-paying companies whose prospects tend to be largely unaffected by broad political and economic decisions. Our stock selection emphasising first world listed equities with pricing power, helped our equity-based portfolios produce double-digit returns as well as above average income yields. Our income funds also produced better returns and higher yields than money market rates despite the bond market volatility.
Looking ahead to 2022, as the economic recovery from the Covid-19 crisis begins to burn itself out, due to reduced monetary and fiscal stimulus, market conditions are likely to become more challenging. For this reason, at Marriott we believe that the next phase of the economic cycle will favour investments which focus on quality, resilience and dividends.
2021 – a red-hot market recovery
Since the onset of the Covid-19 pandemic, the global economy was poised to stage its most robust post-recession recovery in 80 years. The speed of the bounce-back can largely be attributed to: 1) the rapid rollout of vaccines, 2) ultra-accommodative monetary policy; and, 3) unprecedented fiscal stimulus. According to the International Monetary Fund (IMF), fiscal stimulus measures amounted to roughly $17 trillion globally in 2020 and 2021, or almost 20% of global GDP.
Chart 1: Economic stimulus responses to Covid-19 vs 2008 financial crisis
A faster and larger monetary and fiscal response than in any previous recession kept businesses afloat and ensured consumers were soon willing and able to spend again, driving a strong rebound in corporate profits and boosting markets. By the end of 2021 the FTSE All-World share index had rallied by over 16% in USD, delivering a third consecutive year of double-digit returns. Interestingly, it took the US market just 354 days to increase by 100% from its Covid-19 trough – the fastest bull market doubling off a bottom since World War II.
It was a good year for local markets too with the JSE up 27% – the best year for SA stocks in over a decade. While South Africa’s economy has been battered by Covid-19, our market is heavily skewed towards resource stocks (approximately 40%) whose prospects are largely determined by global demand as opposed to local. From a sectoral perspective, it is understandable that cyclical investments such as commodity producers fared best given the swiftness of the recovery. Conversely, typically defensive investments such as government bonds performed relatively poorly. Interestingly, South Africa was a standout performer relative to other emerging markets. The MSCI emerging market index was down 2% in USD, well below the 19% USD JSE return and the 22% USD return from the developed world.
Chart 2: Expected medium-term GDP losses relative to pre-COVID-19
The divergent performance between emerging and developed economies serves to highlight another important feature of the Covid-19 recovery: its unevenness. It should be noted that around 75% of the approximate $17 trillion in fiscal support was deployed by the major economies of the G-7 (Canada, France, Germany, Italy, Japan, the UK, and the US). These countries were also amongst the first to have access to vaccines. Unsurprisingly, their recoveries have been far more robust and their future prospects brighter. Chart 2 highlights the greater losses which emerging and developing countries are expected to incur as a result of the crisis.
2022 – a more challenging year for the global economy
Looking ahead to 2022, it is likely that the global economy will move into the next phase of the economic cycle as the red-hot recovery starts to cool down.
The major downside of the recent unparalleled monetary and fiscal stimulus is that demand bounced back faster than supply, triggering bottlenecks and pricing pressures that would normally emerge far later in the economic cycle. Inflation often falls in recessionary times and early in recoveries, then it slowly picks up as the expansion ages. This time, however, it is rebounding far more rapidly, piling pressure onto central banks to hike rates. This is particularly evident in the US where inflation registered 7% in 2021 – the highest since 1982.
In response to the surge in inflation, the bond market is now pricing in the first US rate hike in March 2022 – approximately 24 months after the last interest rate cut and many months earlier than had been anticipated at the beginning of 2021. Significantly, it took approximately seven years (3x longer) before interest rates started to rise after the 2008 Global Financial Crisis. Considering the huge amount of debt globally, it isn’t likely to take many interest rate hikes before higher rates start to weigh on growth. Chart 3 highlights how global debt surged to historic highs during the pandemic.
Chart 3: Global debt expansion
There will likely be far less fiscal stimulus in 2022. As discussed previously, governments