“We basically dug ourselves into a huge hole. And we hope to fill the hole by printing a lot of money. . . What a response we got in 2008 and putting it on steroids. “-Louis-Vincent Gave, CEO, Gavecal
The resumption of business in the wake of the Covid-1 pandemic epidemic, the ballooning of the central bank’s balance sheet, the resurgence of inflation and the competitive dynamics between the United States and China have paved the way for a rich dialogue. Joyce Chang, chair of global research at JPMorgan; And Louis-Vincent Gave, CEO of Gavecal.
Their conversation, hosted by William Blair’s partner Brian Singer, CFA, was held at the CFA Institute’s inaugural Alpha Summit in May and offered an underlying perspective on policy landscapes and investment strategies.
Four main issues have come up.
1. Policy response for Covid-1 to
The panelists noted that the effectiveness of the lockdown varies around the world, but that business shutdowns have resulted in loss of production and job opportunities almost everywhere.
“There’s a narrative that it’s a tradeoff between saving dollars or saving lives and it never happened,” Arnott said. “Death is a family and personal tragedy. So is the destruction of careers and hopes and dreams. ”
Fiscal and monetary policy response to the economic crisis is perfect, debt-fuel government spending and ultra-consistent monetary policies enter the market with a lot of liquidity.
In monetary policy, according to Chang, one of the key developments is a change from an expected, or vision-based response function within the central bank to a result-based one. Rates continue to rise as soon as inflation and unemployment targets are achieved.
“They have learned from the last crisis. They didn’t want to remove the stimulus too soon, ”he said. “But waiting to see what happens next, there’s a real risk of misunderstanding.”
This raises the possibility that the policy may be tightened within the cycle of controlling inflation. Chang said shortening the business cycle, as evidenced by the sharp return to economic activity, further increases the risk of policy mistakes.
“It’s not the standard business cycle,” he said. “A year ago, we all talked about what recovery would be like: is it‘ V ’, is it‘ W ’, is it‘ U ’? It looked like a ‘U’ it was one of the fastest recessions and the fastest rising. ”
Inflation risks have expanded, noting that the epidemic has created widespread supply chain isolation and a less connected world.
“It simply came to our notice then. It’s quite an inflationary shock, “he said. “What we see is that the world is closing in on itself. Instead of accelerating globalization, we have a world that is becoming isolated. ”
During the financial crisis of the 2000 financial year, Gave recalled, monetary stimulus was designed to grow at any cost to curb inflation. In contrast, the current monetary policy trend is much higher and could lead to significantly higher inflation up front with supply-side dynamics.
Regarding the monetary policy situation and the legacy of high levels of government indebtedness, Arnott noted that excess debt slows total growth and that excess spending can divert people’s capital from the private sector and to selected government programs.
“There are a lot more jobs open than people,” he said. “True, unemployment still exists from pre-covid, but it has risen because we are paying people more to not work. If it goes away, we will be fully employed now. ”
Moreover, if the US government accumulates debt without any plan to make it better, Arnott warned, there will be dire consequences.
“When we take an orrow with the intention of repaying, we either repay or we default,” he said. “If we take the orrow with the intention of never repaying, reckless behavior will eventually lose a domestic and global confidence in the currency and the healthy functioning of the U.S. economy.”
2. Deviations from the United States and China
“It’s a strange situation where the biggest man in the room is putting his foot in the gas like never before. And the second guy is braking. ”-Louis-Vincent Gave
The level of financial expansion that the United States is embarking on in recent history is similar.
“Last year, the debt to the U.S. federal government increased by $ 13,000,” Gave said. “In 2008, it increased to about 00 3,500 per American. That’s more than four times what it was in 2008.”
At the same time, China is already tightening monetary and fiscal policy. China’s policy normalization reflects where it found itself during the Kovid-1-induced economic crisis.
“They were first, they were first,” Chang said. “They’re in a position where they can start taking some more proactive steps that I think the market wants to see right now.”
The policy deviation between the two largest economies in the world will result in capital flowing eastwards as China flows mainly in the financial markets. Despite the tensions between the two superpowers, these currents, supported by measures to liberalize financial market access and ownership structures, should provide a thorough supply for the Chinese market and economy.
In fact, with an estimated 5% yield, China’s bond market could reach 160 1.160 billion, Chang predicted.
The net effect will be the continuation of the appreciation of the renminbi against the US dollar, and thus the transfer of purchasing power from the West to the Chinese consumer.
3. Inflation and asset prices
“If you stimulate the economy through economic means, it is like opening fire hydrants and reducing the water pressure in the surroundings. Those who have buckets near the fire hydrant get plenty of water, not the neighborhood. ”- Rob Arnott
Central bank policies have exacerbated inequality by increasing the value of financial assets and have rewarded those who have existing holdings and ways to participate in financial markets.
More generally, global inflation has seen 3% this year compared to 1% last year, continuing a reflection tilt in the medium term, Chang said.
“We are in a different condition than the 200 starting years,” he said. “And I think asset price rebound may continue for some time because you just got your excess savings and your consumer debt is at a 40-year low.”
The concern is that a real discussion on debt sustainability will not take place unless the market is reluctant to finance more debt. It may close for some time if asset prices are bright.
The issue of asset inflation raises concerns about potential bubbles. The essence of the bubble in Arnett’s definition is the expectation of unrealistic growth.
“You need to use incredible growth estimates to earn a risky premium at the current value of an asset,” he said. “Tesla, for example.”
To justify its current stock price, Tesla needs to increase it by 50% per year for the next 10 years, Arnott explained. That’s a 55-fold increase, surpassing Amazon’s 11-fold expansion in the last 10 years.
“If [Tesla] Growing up 50% year on year and ending the decade with a profit margin as the highest profit margin of any major automaker in the last decade, a little over 10%, which would give a discount today of about 30 430 a share, ”he said. It’s below current prices. So it’s a bubble. “
But Arnott went further in his bubble definition, identifying a second essential feature.
“This is that the marginal buyer doesn’t think about the underlying fundamentals and doesn’t think about the assessment models,” he said. “So that’s true in the case of Gamestop. There is a saying, ‘Don’t pay attention to the basics. This is a short pressure. ”
Other stocks that show a bubble-like situation, where the basics seem more or less unnecessary to the marginal buyer, include some FAANG stocks and some Chinese technology stocks.
4. Investment opportunities
“Emerging markets are one of the places where it is not as much owned as it is now. They have no financial place to keep such policies and sustain them. ”- Joyce Chang
One of the most notable features of the equity market over the past decade has been the lower performance of value stocks compared to growth stocks.
“The spread between growth and values is by far the widest, or at least last September it was the largest of all time,” Arnott said.
The spread of the price-to-book ratio between growth stocks and value stocks has reached a height of 10 to 1 at the tech bubble peak, yet measured at 13 to 1 in September 2020. The current spread is back to around 10 to 1, indicating that the value has increased by about basis000 basis points (bps) since September 2020.
“You have to go a long way for this race,” he said.
Turning to fixed income, Gav offers a dark forecast.
“The US Treasury is no longer doing what you want it to do in their portfolio,” he said. “They’re no longer hedging your equity risk.”
How do we know that diversity benefits are declining? In the past year, there have been three different periods when the U.S. equity market fell 5% or more, Gave explained. And every time, U.S. treasuries have also gone down.
So what is the alternative? Emerging markets and Chinese government bonds for fixed income portfolio allocations.
“U.S. Treasury is no longer going to be the fragile anti-building block of your portfolio,” Gave said.
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All posts are the author’s opinion. As such, they should not be construed as investment advice, or the opinions expressed must not reflect the views of the CFA Institute or the author’s employer.
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