Lessons Learned from the Monetary and Fiscal Bazooka
If there is one lesson for investors to take from the unprecedented events of 2020, it is to never underestimate the positive potency of globally coordinated monetary and fiscal policy on capital market values. A decade ago, we watched governments rescue the global financial system from the abyss in the wake of the Great Financial Crisis, but this feat was nothing compared to unprecedented measures taken in 2020. The sheer scale and speed with which governments acted to subsidize locked-down economies, prevent social unrest and underpin investor confidence was breathtaking. While there is no question that such bold action was required to protect the integrity and liquidity of global public capital markets, the speed at which asset prices recovered from the lows of March 23rd was indeed surprising. Both stocks and bonds produced good returns in 2020 despite a menacing and persistent pandemic.
The current consensus outlook for 2021 is that the widespread distribution of vaccines in the first half of the year will set the stage for the gradual normalization of economic and social activity in the second half. It is expected that the gradual reduction of social and economic constraints will unleash a torrent of pent-up consumer demand, which will carry on through to, at least, the first half of 2022. The resulting economic recovery will spur corporate profit growth and low interest rates will keep equities as the asset class of choice. In general, our view does not differ greatly from the consensus, but we are mindful of one potential scenario that could significantly disappoint and one that could deliver well above current expectations.
First the disappointing scenario. If mutations of the COVID-19 virus were to render the current pipeline of vaccines ineffective, then it is highly likely that equity markets would decline sharply from their current all-time highs. It is worth noting that the current US volatility index (VIX) remains historically elevated, indicating that markets at present are taking some of this risk into account.
However, there is no way to predict or to prepare for this scenario other than holding a well-diversified global balanced portfolio (you do) which has proven to work pretty well through the current pandemic.
And you’ll want to be there for the melt-up scenario. Ultra-low interest rates for long term government borrowing may encourage North American and Western European governments to embark upon much needed large scale infrastructure spending. Only made more likely in the United States with the Democrats controlling the Executive Branch and both houses of Congress. Another round of stimulus, particularly of this nature, would further positively impact employment, capital spending and commodity prices. Equity markets under this scenario would most certainly surge higher.
We currently remain overweight equities and underweight fixed income. With respect to equities, we see better opportunity in non-US markets with their greater emphasis on value-oriented sectors such as industrials, financials and economic cyclicals.