Capital Markets in Transition
Over the past 13 years, global capital markets have experienced two extraordinary events – the Great Financial Crisis in 2008-09 and more recently the COVID-19 Pandemic. While these two events were completely unrelated, they had one significant thing in common. That was the unprecedented policy measures taken by governments and central banks to mitigate the financial and social fallout that would have threatened the integrity of the global financial system. To this end, central banks slashed administered interested rates to zero and through open market purchases, flooded the global bond market with liquidity. For their part, governments invoked spending programs which were essentially “open-ended”. These extreme policy measures have been fantastic for asset prices.
Over the same period, we also witnessed an acceleration in technological innovation. Innovation that has fundamentally changed every aspect of our daily lives. This sea change has spawned an unprecedented rise in the market value of a handful of technology and “technology related” equities. Think FAANG (Facebook, Amazon, Apple, Netflix and Google) and the lesser known but equally important international technology equities – Taiwan Semiconductor, Tencent, Samsung and Alibaba. These new behemoths have, in turn, redefined global equity indices.
Unprecedented stimulus and technological innovation have led to an exceptionally long period of above average balanced portfolio (60% equities:40% fixed income) returns. However, as global vaccination rates rise and antivirals are further developed, we expect the COVID-19 Pandemic to wane. If this is the case (and we seriously hope it is), expansionary monetary and fiscal policy will no longer be required suggesting a future investment environment characterized by reduced liquidity, higher interest rates and significantly smaller government largesse.
At the same time, we expect government policy intervention and the regulation of Mega Cap technology companies to gather speed globally. China has demonstrated its resolve – intervening in fintech, education and online gaming. And in the US, the recent revelation of Facebook’s “Big Tobacco” moment (we know… but we don’t care that Instagram is bad for you) has emboldened the cry for regulation. An ending to the unchecked power of Mega Cap technology will most certainly be bad for equity valuations.
Balanced portfolio returns have averaged 1.5% above the expected annual target of 7% since 2009. Going forward, we expect nominal balanced portfolio returns in the 4% to 6% range as both interest rates and price earnings multiples normalize. In this environment, we plan to actively manage interest rate sensitivity by reducing average duration in the fixed income allocation. Equities will remain overweight with a bias toward more traditional regional allocations – particularly developed international markets (Europe and Japan). After many years of being above average, US equity allocations will be brought into line with the benchmark over the next six months. Finally, market volatility will remain a key feature of capital markets for the foreseeable future.