Summary

Gerard Minack began his talk by discussing the impact of the COVID-19 outbreak and its clear negative affect on US GDP. While the initial recovery has been fast, GDP is not expected to recoup all its Covid-19 losses until 2022. Unemployment has also taken a hit and similarly to GDP while it has recovered, we will not see a return to pre-COVID levels until late 2022. Gerard mentioned the potential risk of a global second wave of the virus and how this may have an impact on current optimistic growth forecasts. A further risk that was mentioned is the possibility of premature slashing of income support for unemployed which could stall recovery. He then touched upon inflation and how, historically, you tend to see a trough two years after a recession, which reflects looseness in the labour market. Gerard predicted a brief spike in most inflation measures early next year. Through historical analyses Gerard concludes that we will not see a material pickup in inflation until 2022 at the earliest. The most important outcome of the pandemic is its effect on policy. Gerard points to factors such as high debt, demographics, inequality, globalisation, digitisation, and oligopolisation as causing secular stagnation. Fiscal expansion would help to combat this. Gerard believes fiscal policy will become the principal tool to manage the macro cycle in developed economies. COVID-19 has led to large deficits this year – much as the GFC did in 2008-9 – but the key test will be whether policy will be tightening in the recovery. It was after the GFC, and that was a mistake. Gerard noted he did not think this mistake would be made again. QE is being utilised by many of the world’s banks over the last 12 months, with many copying the actions of the Japanese central bank. If fiscal expansion is sustained, then investment landscape will dramatically change, prompting the end of secular stagnation. Gerard predicts that if secular stagnation ends then the ten-year treasury yield decline will also end, resulting in a 4% increase in 2023/24. Bonds have generated equity-like returns as yields decline, which will become impossible to replicate going forward. Falling interest rates have gone hand in hand with rising non-financial sector leverage. Gerard also predicts that financial leverage will become less attractive in the future which will encourage a transition from financial assets to real assets. Moving onto corporate debt, historically, quantity of debt has been steadily increasing while quality of debt deteriorated; in future Gerard expects greater lender discrimination. Gerard also discussed a potential change in equity-bond correlation. Equities do not rerate when bonds drop to low levels, as shown by historical data, excluding the US. Gerard then highlighted the massive market performance of FAANM. FAANM is now so large their market value is larger than every equity market in the world. Their performance explains why the US is the only major equity market to re-rate in the era of very low rates. Gerard believes that we may now see a change in equity leadership where the US gets left behind and value outperforms growth, provided we see a transition to fiscal led policy. Gerard concluded that the result of these changes is that there will be lower returns on fixed income, leverage is becoming less attractive, investors will become more discriminatory, equity/bond correlation will change to positive and rising yield will shift equity leadership.

Topics