There has been no shortage of market noise in recent months and the sheer number of black swan events has kept market participants in a heightened state of alert.
This may prove to be no bad thing but it does run the risk of policy error. For example, the European Central Bank may be paying too much attention to near-term inflation data and overlooking the sharp slowdown in money supply growth, which could ultimately manifest itself in lower economic growth for the eurozone.
In contrast, uncertainty is staying the hand of the Bank of England and US Fed from engaging in monetary tightening. In maintaining an accommodative stance, both have been helped by weak economic growth figures. Even labour market data, which has shown some improvement, is not yet at buoyant levels. Fears that imported high commodity prices will lead to more aggressive wage demands have yet to surface, giving some credence to the view that the recent spike in input and retail prices will wash through the system without leaving a permanent stain.
Emerging markets have under-performed developed markets over the last six months largely due to concerns about monetary tightening. The increased political risk from events in North Africa and fears about supply chain disruption following Japan’s earthquake have played a part in reducing risk appetite. However, the main factor behind the relative weakness of emerging markets has been monetary tightening in China, India and Brazil together with the implications of a possible slowdown in Western demand from developed country tightening.
The rise in food prices was marked last summer and as we progress through 2011, the year-on-year comparisons for this sector could become less onerous. Simple arithmetic, reflected in the fact food has a high weighting in emerging market inflation indices, means pressure for further tightening in emerging markets could dissipate through 2011.
As soon as the markets get the faintest hint that aggressive monetary tightening in emerging markets may be drawing to a close, the money that switched across to developed markets could start flooding back. This has implications not just for emerging markets but for sentiment towards equities in general. Investors view emerging markets as the growth engine within their portfolios. If this area is underperforming, the portfolio does not appear to be functioning as expected. A pick-up in emerging market performance should therefore be beneficial for risk assets generally.
Inflation as a story tends to ebb and flow. It has been flowing for some time now and is overdue an ebbing. Lead indicators are pointing to some global economic softness over summer. This need not read badly for investors as economic growth that disappoints the market should push back expectations of monetary tightening, particularly in the US. Equities tend to respond well to the prospect of ongoing cheap financing and the lower yield competition that arises from low interest rates. The question then remains whether emerging markets or developed markets offer the stronger prospect.
Bill McQuaker is head of multi-manager at Henderson Global Investors