Why the Capital Cycle Matter so Much!

The last few weeks have been volatile, they say, but economies are still growing nicely.

Household savings are high, unemployment is low and both those things bode well for consumption in 2022, as does the shift in favour of fiscal policy by governments (they are all big spenders now).

Supply chain bottlenecks are also likely to ease in 2022, something that will both allow a gross-domestic-product-boosting inventory re-build and ease inflation.

We are also, as one note from Invesco puts it, “living in one of the most noteworthy periods of change in history”, with the digitalisation of everything creating extraordinary new industries and medical advances yielding astonishing new ways of treating human diseases.

And Covid? By next year it may be that the expanded use of high efficacy antiviral pills will have pushed it some way down everyone’s list of things to worry about.

Add all this up and global growth is likely to be over 4% next year – well above the norm for the past decade.

That, we are also told, is just the kind of background that is pleasantly supportive of share prices.

The analysts at Barclays note that this year has been characterised by non-stop earnings upgrades – companies just keep doing better than we expect them to. That, commentators believe, is likely to keep happening, partly because of the good growth but also because Covid has “crushed competition” – the way in which the pandemic has “disproportionately hurt small and medium-sized businesses” means that there may have been a shift in the share of income going to larger (listed) firms from smaller (unlisted) ones.

A lot of this makes total sense. But there are a few problems, nevertheless.

This appraisal ignores policy risk. It ignores price. And it ignores the capital cycle.

Looking at the latter, the idea here is simple: you should look at how much capital is flooding into a sector rather than focusing on price alone. The more capital there is, the more likely it is that sector will see oversupply and price collapse.

Right now it is easy to see those sectors in which capital seems both free and unlimited (renewable energy being the obvious example), and easy to see where it has been neither for some time (for instance, old energy and mining). This is a combination that should make investing feel both harder (the risks are high) and easier (there are obvious opportunities).

So what should the 2022 outlooks really say? That markets are fragile and set to be very volatile. That there might well be good times ahead, but that many prices already discount 20 years of partying. And perhaps that investors should bias their holdings towards cheaper sectors and, in particular, towards the capital-starved ones that it turns out we need as much as we ever did.