While we continue to monitor growing investor optimism and acknowledge that there is some recalibration of the pace and slope of the economic recovery (due to vaccine logistic disruptions), we struggle to see broad-based evidence of the euphoria or market deterioration that would normally herald an oncoming market collapse. Equities resumed the trend higher over the past week on the back of better than expected earnings and early indications that the news on the COVID front may improve in the coming weeks. Of particular note during the week, and consistent with our economic recovery outlook, was the breakout in long-term bond yields across markets (charts below). Even German yields are turning higher!

Despite the short-term challenges faced with new strains of the virus and with logistical bottlenecks, there is building evidence (in addition to rising yields) that investors are expecting this soft patch to give way to stronger economic momentum. It is useful to note that COVID cases inversely lead consumer confidence by three weeks and that new cases are starting to fall (US chart below). With historically high savings ratio and more fiscal stimulus on the way we would expect healthy consumer spending as the year moves on.

One trend that we are monitoring closely is the noticeable pick up in many measures of inflation. This should be placed in the context that overall inflation remains low and quite some way from levels that might be considered a negative for financial markets. The rise in bond yields is signaling both a rise in expected growth and expected inflation. The chart below shows the steady rise in breakeven inflation rates across many global markets – these yields basically contain investor expectations of future inflation levels.

There have been many false dawns over the last twenty years for rising inflation. Of note this time is the broadening sources of price rises. Below we highlight a few interesting charts showing the rise in food prices in 2020, the recovery in many commodity prices, and container freight rates that are more than double the average of the last 7 years.

As stated previously, this trend has some way to go before it would become a destabilising influence on financial markets. However, in the mean time we view this trend as an additional tailwind for the majority of cyclical stocks as pricing power should return to accompany recovering business volumes. After an extended period of underperformance we are starting to witness early signs of relative strong performance from the two sectors that should benefit the most from rising inflation.

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