The Monthly View – February 2021

Riding the Bull

Despite continued lockdowns in many parts of the world, stock markets continued to move higher most of January until the last few days of the month when we experienced increased volatility in the markets. This was partly caused by the massive rally in shares of GameStop, which could send a message to retail investors that the “sky is the limit” when it comes to buying stocks, and anyone who bets otherwise risks having their account blown up. At least in the near term, that is bullish for equities.

We must remember that stock markets typically lead economic data. Or more accurately, stock markets price economic activity in real time, while economic data is typically at least a couple of weeks old, if not months, as there is no objective way to measure macro data in real time. If the equity market is right, it means that economic activity will continue to recover.

There are also early signs suggesting that the recent wave of the Covid pandemic is subsiding: hospitalizations appear to have peaked in the U.S. and in Europe, and the number of new cases is trending lower. At the moment, the U.S. seems to be leading in the roll out of vaccines, which could allow the U.S. economy to open sooner than other countries. As the U.S. economy is the world largest, that is a positive for global economic growth.

Will We See Higher Inflation?

A big question is whether the enormous rise in money growth over the past year is likely to lead to higher inflation over the coming 6-12 months. This has been the main question from investors who have been unnerved by the surge in money growth and the big increase in the US government budget deficit, which could be as high as 22-25% of Gross Domestic Product (GDP) this year.

Any link between money growth and inflation must come through spending, so the question of whether a surge in money will lead to higher inflation is the same as asking whether the massive amount of savings that have been accumulated over the past year are likely to be spent, and over what period.

How Could Inflation Develop?

If households expect prices to increase but then fall back down once the stimulus ends, they may defer some of their spending until prices return to normal. This could prevent prices from rising in the first place. In contrast, if households expect prices to rise and then keep rising, they may try to expedite their purchases. This would supercharge spending.

There is a self-fulfilling process at work here. If households expect prices to remain broadly stable, then they will remain broadly stable. If households expect prices to rise a lot, then they will rise a lot. Remember last year’s Great Toilet Paper Shortage? And then imagine what would happen if people expected shortages or price hikes on an economy-wide scale.

Our baseline view is that inflation will increase only modestly over the next few years before accelerating in the middle of the decade. Nevertheless, the risks are skewed towards an earlier and sharper increase in inflation in the U.S. and, to a lesser extent, in the other countries.

The first round of stimulus in 2020 left US households with $1.5 trillion in excess savings, equivalent to 10% of annual consumption. The stimulus deal Congress reached in December combined with President Biden’s proposed package would inject an additional $300 billion per month into the U.S. economy through the end of September.

Republicans and centrist Democrats in the Senate may force Biden to slim down his stimulus plans to something closer to $1 trillion. Nevertheless, this still would provide about $200 billion in additional monthly support.

Why This Time is Different

In his 2011 State of The Union Address, President Obama declared that “Families across the country are tightening their belts and making tough decisions. The federal government should do the same.” And so, the government did.

The U.S. was not alone. Most advanced economies tightened fiscal policy not long after the Great Recession of 2008 officially ended. In the case of countries such as Italy and Spain, the tightening came in response to market duress. In other cases, such as those involving Germany and the UK, the tightening occurred against the backdrop of fairly low borrowing costs.

This time the reaction of policy makers after a global recession has been very different. After the pandemic struck, most governments were very quick to loosen fiscal policy. However, unlike ten years ago, calls for reducing government debt have been a lot more muted this time around.

Back in 2010, the economic thinking was that “monetary policy must be normalized” and that “exit from exceptional fiscal support must start now, or by 2011 at the latest.” Today, the Organisation for Economic Co-operation and Development (OECD) admits that it made a “mistake” in pushing for austerity so soon after the recession ended. “The first lesson is to make sure governments are not tightening in the one to two years following the trough of GDP” explained Laurence Boone, the OECD’s current chief economist, to the Financial Times earlier this month.

The OECD’s change of heart partly reflects political reality – assistance for businesses and workers who lost income due to lockdowns is more acceptable than bailouts for banks and for homeowners who took on more debt than they could afford.

There is an important economic dimension to the different approach as well. Back in 2010 many economists were forecasting that the huge spike in monetary and fiscal stimulus would lead to much higher interest rates and inflation. This never materialized. Despite soaring debt levels, real bond yields in the U.S. and most other economies are near record lows.

So, this time around policy makers around world have taken the politically convenient path of supporting their economies perhaps even more than necessary. If everyone is doing it, why not you.

And with many countries being able to borrow at close to zero or even negative interest rates, why would you not.

This is one of the key reasons why we remain optimistic about the recovery of global economic activity for the next 12-24 months.

Investment Implications

Forward equity earnings already price in a complete earnings recovery, but for now there is no sign of waning forward earnings momentum. Net revisions and positive earnings surprises remain solidly positive.

The markets have largely priced in the most likely economic outcome for 2021, but our base case still favors equities over bonds. Unlike in 2000, bond yields today are well below the earnings yield on stocks.

Global stocks have the potential to outperform U.S. stocks this year. The U.S. dollar is likely to continue to trend lower, albeit at a slower pace.

The risk of higher inflation is unsettling to many investors. However, in itself, inflation is not necessarily bad for stocks. Inflation is only bad for stocks when it triggers monetary policy tightening. In the absence of rate hikes, rising inflation would push real rates lower. This would be quite good for stocks, as the experience of the past nine months demonstrates.

Of course, if both actual inflation and inflation expectations were to jump too much, the Fed would have to intervene. With that in mind, investors should position their portfolios to withstand rising inflation. This calls for keeping duration low fixed-income portfolios, favoring inflation-protected securities over nominal bonds, and owning more real assets such as gold, commodities, and real estate.

Investment Conclusions

Stock prices are likely to rise in absolute terms despite already elevated multiples, and investors should remain overweight equities relative to government bonds.

The “reopening trade” favors global over U.S. stocks, and value over growth stocks. International stocks are now in a clear uptrend versus their U.S. peers, whereas value stocks have yet to decisively break out. We expect the latter will occur over the coming 6-12 months.

The U.S. dollar is a reliably counter-cyclical currency and has behaved exactly as a counter-cyclical currency should have over the past year. We thus expect a further decline in the dollar over the coming year.


Within a global equity portfolio, the U.S. market underperformed in January mostly because of the strong gains in emerging markets (including China). European stocks, which have significantly underperformed over the course of the pandemic, could finally catch up this year.

Our portfolios started the year well. Our balanced approach of including both growth and value stocks generated outperformance. As did the overweight to emerging markets and to the renewable energy sector.
In fixed income government bonds sold off but corporate bonds and Treasury Inflation-Protected Security (TIPS) performed relatively well.