Active Thinking

At GAM Investments’ latest active thinking forum, two of our brightest investment minds discussed the beneficiaries of an end to the pandemic in Japan and the prospect of more stubborn inflation globally.

09 February 2022

Ernst Glanzmann – Japan Equities

Japan’s equity market remains broadly on the same path, where profit growth is softening but settling at the long-term average of around 8%. With around 60% of companies in the Topix having reported solid Q4 results, there were some reoccurring themes. One theme highlighted the pandemic as a restraining factor and cost pusher. The continuing tightness of parts and supply has negatively impacted the manufacturing space, which is particularly visible in factory automation and automobile areas. Other themes included strongly increased input prices putting profit margins under pressure, as they are passed on slowly, alongside bottlenecks in production caused by partial lockdowns and the availability of the workforce. On the other side of the coin are the basic material suppliers and fuel suppliers who are benefiting from the current tailwind.

An end to the pandemic could noticeably loosen the constraints within Japan and boost profits. Cosmetic companies could be one beneficiary as we move to a maskless environment. China's possible opening of borders, combined with loose monetary policy, would likely improve the flow of goods and stimulate demand. We also believe tourism-related sectors will see a significant rise as a product of easing constraints and visitors from China. Additionally, supply constraints should become less of an issue, which will allow more balanced factory operations and a slowdown in supply-side inflationary pressures. Covid and structural shifts are expected to put more focus on ESG in addition to the constant improvement in corporate governance in Japan. We are expecting this to be a tailwind factor going forward. ESG has been increasingly gaining attention in Japan and supply chain upgrades, including environmental performance and traceability, are required much more than before.

One risk to watch out for is the extent of a slowdown in the US economy. The fading influence of former Covid-related government measures, coupled with an aggressive Fed, could be a negative factor all over the world. The potential Ukraine-Russia conflict may also have implications for payment systems and energy prices. Overall, despite this, we are still in a solid corporate earnings environment.

Adrian Owens – Global Macro and Currency Fixed Income

We have argued for the past 18 months that inflation will not be temporary but will likely prove much more stubborn than many anticipate. However, one thing that has changed in the last few weeks is that the Federal Reserve (Fed), along with the European Central Bank (ECB) and Bank of England, have at last woken up to the fact that there is a huge amount of liquidity in the system and that it is behind the curve.

Although the market has begun to price in rate hikes from the Fed, ECB and Bank of England, we still believe that there are not enough priced into markets.

Over the next few months we are likely to see headline inflation come down a little, largely because of base effects. However, we need to watch core inflation as that is likely to head higher and this is ultimately the inflation figure which troubles central banks more than headline inflation, which can be pushed around by volatile components such as food and energy prices.

There are three main reasons why we think core inflation is heading higher. The primary reason is the labour market, which is very tight. Wage growth is picking up and in the US we have seen a huge drop off in the participation rate, meaning that the labour market has shrunk by about 1.5% in recent years. Additionally, there are some unfavourable demographics in the background. In 2000, China was adding 15 million people to the working age population every year. Today, there is a contraction of about one to two million coming from China because of demographics. China was exporting disinflation; today it is exporting inflation. Factory gate prices in China are running north of 10%. We no longer have those global disinflationary influences we have had over the last couple of decades.

Aside from the employment market, rents make up a third of core personal consumption expenditures (PCE). Anecdotal evidence suggests rents in the US are running at between 8% and 10%. Official numbers in the current inflation reports suggest that they are closer to 4%, however all leading indicators suggest that over the next six months they are heading higher.

The third reason is climate change and the impact that is having in terms of the increased carbon taxes required, and the impact that this is going to have on inflation over the medium term.