2021 Midyear Investment Update

2021 Midyear Investment Update

From healing to growing - our midyear investment outlook highlights bullish view on global economy and equity markets,
despite near-term inflation concerns and expected higher volatility.
Led by the United States, global economic growth will remain strong for the remainder of the year, with much of the world returning to pre-pandemic activity levels by the end of 2021. Policymakers will continue to support economic activity and employment, including by pursuing inflationary policies – which will lead to higher asset prices even as the current consumer-price inflation spike proves temporary.

chart 1
Call 1
Running on high pressure
Consensus point of view: We’re either overheating or the best of the post-pandemic bounceback is already behind us. Either way, it looks a bit worrying.

Counterpoint view: We’re more bullish than the consensus. We think policymakers want to ‘run the economy hot’ as there’s still considerable spare capacity. They’ll do this via government stimulus measures. We see limited overheating risks and believe growth is likely to be sustainably strong throughout the rest of the year. Cyclical recovery and reflation are still in play.
chart 2
Call 2
The inflation head fake
Consensus point of view: There are two camps: those who believe we’re set for a secular pickup in inflation and those who believe disinflation will ultimately remain well entrenched. So both inflation and disinflation risks have increased.

Counterpoint view: While we do see continued inflation in asset prices, we think consumer price inflation is likely to stay moderate following a temporary spike. Labour markets are only likely to put upward pressure on inflation gradually, which is why we think the major central banks won’t tighten their policies for some time. Over the long term, technological innovation and ageing populations are likely to continue to be disinflationary forces.
chart 3
Call 3
Steeper for longer
Consensus point of view: As the cycle matures, the yield curve should flatten as rate hikes approach. The market is pricing the first Fed rate hike for early 2023, with a probability of a hike as soon as 2022.

Counterpoint view: While this is what tends to happen when economic activity shifts to mid-cycle, this time around we believe central banks aim to allow governments to fund their large-scale stimulus programmes at affordable rates. We’re more dovish than the market and think that, within a reasonable range, central banks will likely allow long-term bond yields to rise as long as this is because of faster growth, while anchoring short-term yields at very low levels.
chart 4
Call 4
The power of words
Consensus point of view: Market conditions could become more volatile either because things go wrong and there’s less policy ammunition left or because it’s difficult to withdraw the stimulus and financial instability rises.

Counterpoint view: We agree that volatility will probably rise from here. But we differ on the nature of its potential rise. Unexpected events could derail the recovery, such as new virus variants. But the main risk, to us, is too much of a good thing: stronger-than-expected growth and perhaps a more protracted period of inflation could lead to a repricing in the bond market, flattening yield curves as investors test central banks’ resolve to refrain from hiking. Rather than raising equity market volatility in and by itself, this could raise bond market volatility first and foremost, and affect risk assets as a consequence, especially at a time when discussions around the tapering of asset purchases will likely intensify. But it’s unlikely to happen in a straight line, with alternating periods of rising bond yields and risk asset outperformance.
chart 5
Call 5
Back to the future
Consensus point of view: Overall, long-term productivity should remain subdued, and we don’t know whether it will ever pick up.

Counterpoint view: An underappreciated legacy of Covid-19 is that it has accelerated the shift from physical to digital. What’s more, breakthrough innovation, booming capital expenditure in technology and the fast adoption of new technologies are all coming through. This may boost productivity, earnings and economic growth. Even though early-cycle phases are generally associated with outperformance in assets leveraged to faster growth and beneficiaries of steeper yield curves, we’re positive on themes such as technological disruption and think the pandemic is likely to have accelerated this process. While getting the micro nuances right is just as important as spotting the wider macro trend, our longer-term forecast is more positive than the consensus view.