Looking beyond the restart

A consequential juncture

The powerful economic restart after the Covid-19 shock is playing out. We remain pro-risk as the restart broadens. The more consequential question: What lies beyond? This juncture could be as critical as the shift to the neoliberal consensus in the 1980s. The post-global financial crisis (GFC) playbook won’t work, in our view, as the historic monetary-fiscal collaboration to bridge the pandemic should lead to a higher inflation regime. This means we don’t expect another decade-long bull market in stocks and bonds.

A restart is not a traditional business cycle recovery – you can only turn the lights back on once, so to speak. Fiscal stimulus and easy monetary policy have provided a bridge through the pandemic. We have estimated the U.S. has seen more than four times the stimulus compared with the GFC for less than one-quarter the shock. We see a wide range of macro outcomes as a result.

Higher inflation regime

New policy paradigms mean central banks are now attempting to overshoot inflation targets to make up for past misses. See the chart below. The shaded region shows how high the Fed would likely need to let inflation run to make up for previous shortfalls. This is a major shift from the neoliberal consensus adopted in the early 1980s that helped contain inflation and usher in a four-decade period of falling inflation and interest rates. Yet markets have not yet bought the narrative, and are pricing in a more rapid lift-off in policy rates than what the Federal Reserve’s new policy framework and projections indicate. This mismatch and resulting uncertainty could stoke volatility.

We expect a higher inflation regime in the medium term – as a result of a more muted monetary response than in the past. We see recent bond yield rises primarily driven by inflation, rather changes in the expected path of policy rates, making the unique environment that we have called the new nominal constructive for equities.

Only getting into the inflation zone
Average Fed inflation projections vs. average make-up, 2015-2023

Staying moderately pro-risk

We are moderately pro-risk and look for opportunities from any turbulence to increase risk: Negative real, or inflation-adjusted, bond yields should support equities. We see potential for cyclical shares and regions to benefit form a broadening restart. We are turning positive on European equities and upgrading Japanese equities to neutral – and cut U.S. equities to neutral. Even if yields remain low, the direction of travel is up – and we remain underweight developed market government bonds.

For the first time, we break out Chinese assets from emerging markets as distinct tactical allocations. We believe Beijing’s focus on quality growth should bear fruit, keeping us tactically neutral on Chinese equities but heavily overweight strategically.

The path to net-zero carbon emissions has a starting point and potential destination – but there is no clear roadmap yet for getting there. Some of the coming changes may be abrupt – and add to supply and demand disruptions among commodities. We see opportunities along the way, with private market financing playing a key role.

Staying pro-risk

The broadening economic restart, coupled with global central banks’ resolve to maintain easy financial conditions, keeps us pro-risk. We favor equities over credit and government bonds on both a strategic and tactical investment horizon.

Directional views

Strategic (long-term) and tactical (6-12 month) views on broad asset classes, December 2020

Our granular views indicate how we think individual assets will perform against broad asset classes. We indicate different levels of conviction.

Tactical granular views

Six to 12-month tactical views on selected assets vs. broad global asset classes by level of conviction, December 2020