As the vaccination programme is rolled out across the world, there is a growing expectation that the global economy will recover and normalise.
We retain our pro-equity stance, underpinned by a strong outlook for profits and accelerating economic growth. However, monetary policies in those countries that are more advanced in their recovery process could tighten in the year ahead, leading to heightened volatility for global markets.
We expect the global economy to experience two to three years of above-trend growth, which should translate into positive earnings growth. This quarter may see a peak in the global economic growth rate but it should, nonetheless, remain positive. However, investors are cognisant that such a recovery will continue to be highly variable across countries.
The monetary and fiscal policies implemented in response to the pandemic may make portfolio diversification more difficult. With inflation rising and economic growth normalising, stock and bond prices may become positively correlated, although depressed bond yields are likely to offer lower returns. In the near-term, it will be important to manage portfolios actively, using cash, dynamic asset allocation and alternative assets if necessary. As we look for other sources of diversification, we do not see a compelling case for holding gold, given the risk that real rates increase over time. Instead, we prefer to invest in a narrowing of the spread between US and European government bond yields. There is room for nominal growth in Europe and the US to converge, with US yields having already made part of this adjustment. It will be vital that investors continue to analyse risk scenarios such as periods of accelerating inflation or tail risks associated with emerging virus variants.
The prospect of an increase in inflation, in the US and other countries, is undoubtedly on investors’ minds. The recent increase in the Federal Open Market Committee (FOMC) members’ expectations of future interest rate changes is a natural first step towards normalisation. It limits the perception that the Fed will remain behind the curve if economic data improve, whilst maintaining their easing stance.
We expect inflation to peak in the US and marginally accelerate in Europe this quarter, although the risk is to the upside, given a backdrop of supply constraints and high resource prices. Central banks are unlikely to be in a hurry to tighten financial conditions before seeing more evidence of a sustained demand-led recovery.
The dramatic rise in government spending during the pandemic will have long-lasting effects. Successful management of the fiscal deficit will require a combination of low government bond yields, favourable refinancing conditions and measures to control the budget deficit. US President Biden recently announced proposals to raise taxes, and higher corporate taxes will put pressure on the earnings of large US corporations. Although we expect that some of this negative impact will be offset by investments and spending from the various stimulus packages.
Global growth could also be driven more by services than manufacturing going forward. However, this will continue to be a function of how the pandemic develops in individual countries. Meanwhile, we expect a continued rotation towards quality value and cyclical stocks. We favour developed market over emerging market equities, with European and UK stocks most preferred. Returns across emerging market assets should also continue to diverge as a function of vaccine roll-outs, commodity prices and diverging domestic fiscal and monetary policies. Investors may consider moving into non-US equity markets such as Europe and Japan. These markets have lagged the US and offer some upside for earnings to surprise positively.
Finally, one result of the extraordinary stimulus has been the rise in crypto commodities and special purpose acquisition companies (SPACs). We have not recommended that our clients should invest in cryptocurrencies. They are highly speculative, susceptible to manipulation and poorly regulated, with no tangible way to value them. Blockchain and tokenisation are, however, important technological developments that will fundamentally transform the way in which we operate and transact as an industry.
The battle to defeat COVID-19 remains fraught with danger; we cannot know how this will play out and policy errors may still be made. Actively managed asset classes offer some portfolio benefits as imbalances are mounting and the dispersion between asset prices increases. 2020, for example, was a record year for active managers. As the role of government bonds in diversifying portfolios is arguably reaching its limit, multi-asset teams and active security selection will play an increasingly important role. New opportunities and risks will also have to be managed actively with the more systematic adoption of environmental, social and governance (ESG) tilts in investment portfolios. Finally, asset managers are likely to expand their role and help their clients manage extra-financial risks and contribute to their solutions.
Aymeric Forest, global head of multi-asset solutions, Aberdeen Standard Investments
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