Equity markets have continued to make gains despite concerns around the new delta variant of COVID‑19 as accelerated vaccine distribution has helped fuel expectations of a relative "return to normal." Within equity markets, much debate centers on the future path of interest rates, inflation, and economic growth. Here, we analyze where we believe we are in this current cycle.
Asset prices are high because interest rates remain low, and there is no credit cycle to act as a disruptor. Both governments and central banks have proven to be a good backstop to a global pandemic that would have otherwise had much more severe consequences for financial markets without the unprecedented intervention taken. The outcome is that there appears to be little systematic risk if interest rates can stay at low levels and COVID‑19 slowly gets better. However, we are seeing ample examples of careless risk‑taking in financial markets. History suggests that this type of behavior should be actively managed within portfolios.
"Absurd" Inflation Is Likely to Fall
We are witnessing "absurd" inflation in many areas of the economy, as well as general inflation in the labor market. We agree with the U.S. Federal Reserve (Fed) that absurd inflation is transitory; lumber, DRAM,1 and used cars are pockets of absurd inflation we'd highlight. The question of whether labor inflation becomes embedded is still one to be resolved. While a degree of labor inflation is a good thing, an escalation would likely necessitate a change in monetary policy that could potentially disrupt the cycle.
We believe that demographics and technology, however, remain powerful structural forces that can continue to put downward pressure on long‑term inflation trends. These forces have not disappeared and should return as economies normalize.
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