Yves Bonzon, Julius Baer’s Group Chief Investment Officer, gives us his view on the policy response to the current crisis and beyond.
After reaching all-time highs, tech stocks have been especially hard-hit in the latest market consolidation. Is this the end of the US tech-led bull market?
“The FAANMGs (Facebook, Apple, Amazon, Netflix, Microsoft and Google), the 6 US leading technology platforms, have outperformed the market both on the way down, when the market collapsed back in March, and on the way up, recovering their market losses within less than two months. They have continued to lead throughout the summer months, rallying to a record USD 7.5 trillion of market capitalization. Their performance is equally split between valuation multiples expansion and earnings growth as, ironically, their business models benefited from physical distancing measures. Nonetheless, their valuations have reached very high levels. However, positive factors such as continued monetary stimulus as well as supportive technicals suggest that this sell-off is a healthy correction unwinding accumulated extreme positions. Value stocks trade at record low relative valuations, yet, this situation is happening in the context of a once or twice in a century economic revolution, the rise of the digital economy. The equity bull market is still in place.”
So currently you see no policy risk?
“The US Federal Reserve (Fed) have learned their lessons from the 2008 Great Financial Crisis and it is safe to say that liquidity will remain abundant for months and years to come. This has been confirmed in Jerome Powell’s Jackson Hole speech, where he announced the Fed will adopt ‘average inflation targeting’, allowing inflation to overshoot above 2% if it has previously undershot. This confirms what we have been arguing since 2019 - the Fed will no longer raise rates pre-emptively. They have shifted to permanent easing mode. Other central banks are bound to do the same.
Where the real risk lies, is with fiscal policy. Unlike monetary levers, where decisions are taken by a small number of decision-makers, fiscal policy involves many parties with distinct political backgrounds and needs to be renewed on a regular basis. In Europe the agreed upon recovery fund is a step in the right direction and an encouraging sign for future unified fiscal action in the single block, but more is needed. In the US, better than expected labour market conditions and supportive leading indicators may stall negotiations on subsequent stimulus packages.”
Public debt is record high in many countries and large stimulus packages have already been put in place. How much more public spending can the economy support?
“Proponents of fiscal orthodoxy may look on in horror at the unprecedented size of fiscal deficits and debt to GDP projections. But they oversimplify a complex matter. Apart from the arbitrary nature of these statistics, right now, deflationary forces are way stronger and way more stimulus will be needed to compensate for the private sector income losses the crisis has brought on. If governments do not compensate lost private sector spending, economies will inevitably contract further. The relationship is mechanical. As for the legacy of public deficits in the long-run, as proponents of Modern Monetary Theory (MMT) explain, public debt and excessive inflation is not a one-to-one relationship. According to MMT, countries that can borrow in their own currency, such as the United States or Switzerland, can continue to run large public deficits as long as their economy’s productive capacity is not fully utilised and if public money is spent wisely.”
Are you suggesting MMT will be widely accepted?
“When and to what extent MMT will become part of the policy paradigm remains to be seen, but we are heading in that direction. The Coronavirus crisis definitely accelerated this process. The Fed’s new policy framework is part of it, as higher inflation ceases to be taboo and guarantees easy monetary conditions for years to come. For MMT to become a standard feature however, recurring public deficits and large public debt must be widely accepted.”
What does MMT mean for investors?
“In the medium to long term, MMT policies should reflate the economy, which would be supportive for real assets such as gold. Global reflation is also a key condition for value stocks to structurally outperform growth companies. We are not there yet. In the meantime, monetary policy will continue to be loose and interest rates will be held at their current depressed levels for the foreseeable future. The Fed’s new policy framework even hints at yield curve control, suggesting long-term rates will also be anchored at lower levels. In this environment of financial repression, companies able to provide ample free cash flows will continue to outperform. We favour assets with positive real yields such as Asian REITs and Chinese CNY bonds. Chinese assets, by virtue of their superior return potential and diversification benefits, are rising to core asset class as the Chinese market becomes hard to ignore. We see the Chinese 60/40 portfolio as a hard one to beat this decade.”
- The greatest policy risk today is the withdrawal of fiscal stimulus, not public deficits.
- MMT-inspired policies would eventually reflate the global economy.
- In the meantime, financial repression is alive and well. An investor’s strategic asset allocation should favour real over nominal claims.