Structural systemic change or cyclical mini-boom in the US? Regardless of the answer to this question, now central to investors’ decision-making, this is likely a moment of truth for the markets, with several possible paths going forward.
One route could be that the rise in inflation in the coming months is only a temporary and purely American spike, due to base effects and a boost in consumption from the stimulus plan. In that case, central banks can reunite their various objectives (moderate inflation, full employment, preservation of favourable financial conditions for businesses and governments) while remaining accommodative for several more years. If that is the case, investors can hold on to their secular Growth stocks as well as their long-duration assets.
The other route is that we see the end of the long downwards trend in rates which would itself reflect pre-crisis equilibriums (moderate inflation, cheap energy, policy-mix more favourable for businesses than employees). Here central banks would face the major medium-term dilemma of deciding between inflation control, on the one hand, and full employment and financing, on the other. And if that scenario comes to pass, market demand would shift more towards commodities and Cyclical stocks than sovereign bonds.
Certain indicators show we are likely at a crossroad. Rising inflation expectations are the first sign. The change in the equity/bond correlation is another manifestation of this shift. The outperformance by value equities, which had fallen out of favour in the last 10 years, is also a sign of what appears to be a new paradigm.
Whether we are experiencing systemic change or just a cyclical normalisation like those of the past, this market regime will have to find a new equilibrium point. That is the entire debate around the stabilisation point to be found on the US 10-year yield, which has been bolstered by opposing forces. Finance can sometimes be better understood as a physics problem (a balance of forces, with demand and inflation on one side and central banks and savings on the other).
The importance that these narratives have taken in today’s financial world is cause for concern. As with ideology, one narrative follows another: in a very short time we have moved from the secular stagnation narrative to that of secular reflation. Objectively, there are many reasons to subscribe to it, in particular a political consensus in democracies that need to reconnect with their middle class. But for those who remember the new economy narrative in 2000, this might be a reason to remain somewhat cautious before embracing it wholeheartedly.
But what is a narrative? A representation of reality that seeks to confirm a hypothesis and sometimes deviates from the facts.
In reality, there is no place for ideology when it comes to asset allocation. We are living in rather Darwinian times that are favourable for investors who can adjust pragmatically and gradually to the new reality and incorporate these new parameters into their analytical framework.
Believing that the formulas of the past will continue to work is just as great a danger as ideology; this is true for both economic policy and allocation.
Any comparison with the low-inflation decade is rendered worthless by the fact that 10 years ago we exited a liquidity crisis through asset price reflation, orchestrated by the central banks. This time we are exiting a health crisis through the massive distribution of cash to US households. The consequences will necessarily be different, and the past heroes of asset allocation (gold, technology, treasury bills) will not be the sacred cows for all eternity.
Monthly House View, 19/03/2021 release - Excerpt of the Editorial
March 26, 2021