Bursar’s Review Summer 2021 Sample

Summer 2021 www.theisba.org.uk 10 Finance Equity market corrections – defined as a fall of 10 percent or more from the most recent peak – are more common than most people realise, occurring in more than half of all calendar years since 1964. The median peak-to-trough fall of the Standard and Poor’s 500 (S&P) during any year was 11 percent. An important assessment for anyone looking after an endowment is the risk that a commonplace correction could morph into something rarer, something they may not be able to tolerate – a bear market. We think that risk is currently rather low. We have successful vaccination programmes in the west. We have economies that are more resilient to lockdowns anyway – even French GDP managed to grow in Q1. We have huge government support programmes continuing and we have easy monetary and financial conditions. We have a consumption boom ahead of us, but one that is unlikely to be so great that it engenders runaway inflation in our opinion. Rising 10-year bond yields have been causing some consternation among investors, but we think this is the wrong bond yield to look at when considering the likelihood of a bear market. Our analysis shows that rising 10-year yields are usually associated with strong equity returns, and it suggests that changes in short- term real (inflation adjusted) rates are far more important. In fact, the real yield on five-year inflation-linked US Treasuries (TIPS) was lower at the time of writing than at the start of the year. Global investors are most concerned about US inflation and the Federal Reserve’s (Fed’s) reaction, given the bellwether effects of US interest rates. In the US, we expect consumer price index (CPI) inflation to soon breach three percent and core personal consumption expenditure (PCE) inflation – the favoured measure of the Federal Reserve – to head towards 2.5 percent. Fuelling the inflation spike One of the main reasons for a spike in inflation – and not just in the US – is that prices were abnormally low in March and April last year. If you drive a car regularly, energy costs will be one of the more visible price rises. But their sharply increasing contribution to inflation is more about abnormally low prices last year than it is about expensive energy this year, which is why we think energy inflation is likely to fade quickly. It’s also important to note that huge increases in energy inflation have not translated into large spikes in core inflation over the past 40 years. Recent US inflation headlines have made for some uncomfortable reading and led to a pickup in volatility in global equity markets. UK inflation may look relatively tame, but as British schools look forward to a fuller re-opening next year, an important question for bursars to ponder is whether the spike in inflation in the US and elsewhere will be fleeting or driven by more profound, underlying causes that could make it a lasting trend. Will inflation bring out the bears? A market-based measure of inflation expectations,based on the difference in yield between nominal and inflation-protected five- year US government bonds,has risen back to normal levels