This article may have a very grand title, but it serves to highlight the significance of a change to the very tapestry of economic policy-making that has guided central banks and governments since Ronald Reagan and Margaret Thatcher came to power in 1979/80.
As a reminder, both leaders sought to end the era of big government through a combination of tax cuts, reduced social spending and the deregulation of domestic markets. The plan was to change the mix of the social economic market model back towards the private sector. In essence, the idea was that classic supply-side economic reform would deliver increased productivity and enhanced prosperity.
Those of us of a certain age will remember the moribund state in which most economies found themselves in the 1970s. Stagflation was endemic and there was a sense that the whole system was broken, particularly the traditional Anglo-Saxon mixed economy model. The time was ripe for a move in the other direction and the new orthodoxy of the day became fiscal austerity and inflation targeting. The following four decades saw a significant roll-back of the state, economic liberalisation and a return to the more traditional boom-and-bust cycles that result from private credit cycles.
However, the foundations for a radical shift in economic policy occurred during the Global Financial Crisis (GFC) in 2008, when the consequences of multiple credit booms and the excesses that were buried in the private sector finally came home to roost. This marked the beginning of the end of unbridled capitalism and the start of a more active role for the state. At this point, there was no suggestion of abandoning fiscal conservatism, or indeed inflation targeting, but, fearful of the ramifications of the GFC, and with the spectre of deflation looming under the weight of elevated debt levels, central bankers shifted their policy stance in an effort to raise (rather than lower) the inflation rate.
Since that time, the authorities have provided plentiful liquidity in the hope that excess money supply would eventually foster inflation. In fact, the main effect has been to boost asset prices as investors sought refuge from financial repression in the form of near-zero interest rates. Meanwhile, the recovery in the real global economy has remained patchy and trickle-down economics has been deemed a failure, leading to public demands for action. Populism is the ultimate expression of this discontent and, true to form, just as the bankers have given up on monetary prudence, governments have progressively given up on fiscal austerity. Indeed, in the United States, we saw the most profligate Republican Party in history under President Trump; meanwhile, in the UK, a succession of Tory Prime Minsters have set off on spending paths that leave traditional Conservatives vexed.
So, as things stand today, big government is back. The Covid-19 pandemic has served to reinforce the role of the state in our lives and now, governments are fighting on three fronts, namely, the war on corona, the battle against climate change and the challenge of increasing wealth inequality. The comment from Jay Powell that future monetary policy will be set for the benefit of the poorest person in the poorest state in America encapsulates neatly the change of tone from the authorities - in other words, full employment is to be the main goal.
So what are the consequences of a plentiful supply of liquidity from central banks and fiscal largesse from governments worldwide? As the thrust of policy is to generate a higher level of nominal GDP, the expectation is that we will see increasing real GDP growth and, in all probability, higher rates of inflation. To some extent equity investors have voted with their feet in that we have already witnessed a material switch towards “value” stocks (economically sensitive) and away from “defensive growth” (bond proxies) and “speculative growth” stocks over the last six months.
Following some dramatic share price gains, notably since the vaccine news last November, we are at the point where the rotation to value needs to be justified by a meaningful opening up of economies across Europe and the US. On the other side of the argument is the fact that disruptive businesses are largely to be found in the growth camp, so for investors, the answer to the question is not as simple as “sell growth and buy value”.
From an equity style point of view, this is a year to hedge your bets. Additionally, as dividends make a welcome return over the course of the year, income-seeking mandates should provide a stable core for an equity portfolio. Fixed income allocations will need to be managed dynamically as the path of least resistance for bond yields is higher, resulting in bond price declines. Overall, volatility is the order of the day as we brace ourselves for an important sea change in the fiscal and monetary backdrop for assets.
About the Author
Peter Toogood, CIO, Embark Group
Peter launched The Adviser Centre in May 2014, whilst employed by City Financial He was co-founder of the original Forsyth-OBSR Ratings Service in 2002. He joined OBSR in 2008 and was responsible for establishing the firm’s fund advisory business as well as continuing to conduct manager research.
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