China outperforms as “second waves” widen divergence
This week we would like to highlight these two key calls: China’s economic recovery will prove stronger and more resilient than many expect, amid signs that consumer spending is now picking up and lending support to what has so far been an investment-driven rebound in activity. Despite near-term uncertainty, the narrative for financial markets in the coming couple of years will include “risky” assets outperforming “safe” ones as the global economy improves plus rising inflation expectations, led by the US.
The world economy has clawed back about 60% of the output lost in the first half of the year, but recoveries in most parts of the world have already slowed. Prospects now vary according to success in controlling the virus and the policy response. The outlook for Europe has darkened as second waves have prompted new restrictions and fiscal support is being scaled back.
But the US looks more resilient, with risks in both directions relating to the virus and to the possibility of a post-election fiscal stimulus. China will continue to be the key outperformer, although its recovery is doing little to boost growth elsewhere in the world. Meanwhile, inflation will stay very low just about everywhere, implying that the era of unprecedented monetary support is set to continue for at least the next couple of years.
The recovery in risky assets has further to go
The resurgence of COVID-19 cases in major economies and uncertainty about the forthcoming US election could continue to weigh on “risky” assets in the near term. However, we still suspect that the main narrative over the next couple of years will be one of progress in containing the virus, accompanied by a further recovery in the global economy. In our view, those circumstances, combined with the likely policy backdrop, would be consistent with four key themes for asset allocation.
First, we think that “risky” assets would continue to outperform “safe” ones. Second, we envisage that there would be a change in the relative performance of different sectors of the stock market. Third, we anticipate that inflation expectations would continue to rise, and by a bit more in the US than in other advanced economies. And fourth, we suspect that the dollar would decline against most other major currencies.
The Federal reserve has already stated their intention to allow inflation to drift up without any tempering by interest rates rises, as indeed has the Bank of England. In the US there is already evidence of a steepening of the yield curve that indicates stronger economic activity as well as a rise in inflation as well as a recovery in cyclical stocks, in other words more money being spent by consumers on discretionary items. This backs up the point above about the need to be selective in stock selection.
Investors should be thinking about the impact of a return to normal in terms of economic activity. This is based on the assumption that we will learn to live with the virus and that it will become both less virulent and that better medical intervention will help people recover, despite whether an effective vaccine arrives.
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