Advanced economies are going through a major policy shift from neoliberal orthodoxy to ‘state-sponsored capitalism’, with widespread implications for markets. In this interview, Yves Bonzon, Group Chief Investment Officer, highlights the trends likely to dominate in the 2020s.
Q. In what way do the views in your Secular Outlook help asset managers take investment decisions?
A. Every year we gather Julius Baer’s top investment and research experts to carve out the most important secular trends that will shape the economy and capital markets during the decade. This exercise is of the utmost importance, because as long-term investors we cannot afford to swim against the tide. Every decade is characterised by a different economic and investment environment, meaning that the last decade’s leading asset classes are generally superseded by others.
Q. To what extent do you expect a change to established patterns in markets?
A. We are at an important inflection point. Not only are we at the beginning of a decade, a time when new trends are still hidden and simmering under the surface, but we are also at the tail end of four decades of disinflation. Advanced economies are transitioning from neoliberal orthodoxy to an era of ‘state-sponsored capitalism’. The former was characterised by fiscal prudence and monetary policy dominance, while the latter will seek to combine the full forces of both monetary and fiscal levers. The aim is to reduce the growth-debilitating inequalities that have resulted from neoliberal policies. The end game is reflation – and no, we are not there yet, despite what the current inflationary episode might suggest. The extraordinary nature of the Covid-19 recession and pandemic-induced policy response has affected supply and demand in a way that makes it very difficult to separate temporary from more persistent inflationary forces.
Q. Where do you sit in the current debate about whether high inflation is here to stay?
A. We believe that supply bottlenecks, which play a large part in the recent high-inflation readings, are temporary. While there is a trend toward the onshoring of production, global supply chains remain intertwined, and a major dislocation would entail huge losses for everyone, including the US and China. Globalisation is slowing but not reversing. The same transitory argument can be applied to the demand side of the equation. Demand surged following unprecedented US government support to households, but that support is fading. Further, we do not see radical Modern Monetary Theory (MMT)-style policies being implemented for now. Labour market imbalances, which are mostly confined to pandemic-sensitive sectors, will also subside as government support dries up. Moreover, their inflationary impact, if any, was compensated for by the tremendous surge in productivity that followed this downturn. In fact, we believe that this productivity boom will be a long-lasting disinflationary factor. One of its main drivers is the energy transition. While recent energy shortages have sparked higher fossil-fuel prices, this is a bump in the road. Longer term, the energy revolution will tend to increase productivity and depress prices. More generally, widespread technological disruptions – be it in the energy, healthcare, or any other sector – will continue to exert a disinflationary force.
Q. What else have you factored into your inflation versus deflation analysis?
A. First, ageing, particularly in China, is hard to ignore. Given its role as the ‘factory of the world’, China has exported deflation. Yet with an older population and decreased labour supply, which would increase wages, this trend might reverse. That said, reduced demand due to retirees consuming less might work in the opposite direction. Another important topic is that of debt. The world is inundated with debt, which has weighed on consumption in the West for a decade, as private-sector agents have chosen to repair their balance sheets.
Not only are we at the beginning of a decade, a time when new trends are still hidden and simmering under the surface, but we are also at the tail end of four decades of disinflation.
Today, financial assets represent over six times global gross domestic product, and turmoil on markets could trigger a severe wealth effect that takes down the real economy down as well – what we call ‘the tail wagging the dog’. Can nominal interest rates, following inflation, truly rise without triggering a major downturn? Most likely not. Throughout the current decade, these structural forces will continue to push and pull, guiding the bottoming process of inflation and interest rates. In the long term, we believe that developed economies will use unorthodox policies to reflate – including central bank deficit financing or negative taxation – crucially unlocking demand from poorer households.
Q. What other topics are your team focusing on?
A. China has received a lot of attention since it introduced the ‘common prosperity’ objective. But we are keeping China as a stand-alone core asset class despite increased regulatory risks. Climate-change risks and ESG investing (Investments that consider environmental, social, and governance criteria) are also more prominent topics, becoming an integral part of the investment process.
Notably, many key Secular Outlook themes from the past few years have accelerated in the wake of the pandemic. The rise in fiscal activism, the growing rift between China and the US, as well as the rapid deployment of mRNA technology in the fight against Covid-19 have given us a glimpse of what the world might look like in a decade’s time. For further insight into today’s inflection point, I would encourage asset managers to read this third edition of our Secular Outlook 2020-2029.