The US Congress is currently discussing another stimulus package. It could lead to the government providing as much as an additional $3tn in support for the economy.
This follows the $2tn package that the 27 European Union governments agreed to last weekend.
There is no question that the scale of these ongoing interventions is having a significant impact on asset prices. It is, however, hard to tell how much, and for how long.
Investors therefore have difficult allocation decisions to make in the face of this uncertainty.
‘As we pass the midway point of 2020, it still appears too early to pursue additional investment risk, in our view,’ said Michael Hasenstab, CIO at Templeton Global Macro. ‘Recent rallies in risk assets appear to under-appreciate the ongoing economic damage and the risks for successive waves of infections that could further suppress economic activity.
‘Some economic data have improved in recent months, but the figures reflect a rebound from the extreme shocks in March and April, not early signs of a trending growth recovery,’ he added. ‘A V-shaped recovery is highly unlikely, in our view, given the magnitude of job losses, massive aggregate demand destruction, capacity constraints in reopening and ongoing economic damage that is incapable of being reversed in the short run. Instead, we anticipate a more drawn-out gradual recovery.’
More and more?
That being the case, the question becomes how much more stimulus might we still see?
‘We have seen an ongoing commitment from central bankers to do “whatever it takes” and growing evidence of the coordination of monetary and fiscal policy, that has become a new normal,’ said Ed Perks (pictured), CIO at Franklin Templeton Multi-Asset Solutions. ‘However, ongoing—stimulus may be required. We see policymakers having no alternative but to continue their support. The next question we ask is “for how long?”’
It’s also important to consider how much more impact more stimulus can actually have.
‘The current recession created a gap in private sector income statements and balance sheets that has not yet repaired in many sectors,’ said Perks. ‘This gap has been temporarily filled by large-scale fiscal stimulus and monetised by central banks.
‘As an expansion ensues, barring a Covid-19 second wave, it remains to be seen whether policymakers can continue to plug this gap in a fragile, recovering economy, especially in an election year with heightened political risks. Likewise, there is also a risk of diminishing returns to policy actions.’
Perks feels that in this environment investors should treat high yield bonds with caution.
‘The market is currently placing a great deal of faith in the ability of policymakers to underpin the full breadth of market sectors,’ he said. ‘In the case of high yield, the inability of the Fed to protect the solvency of companies makes a rise in defaults highly probable. In our opinion, the most attractive balance of risk and reward is found in higher-rated, investment- grade corporate bonds.’
Sonal Desai, CIO for Franklin Templeton Fixed Income (pictured), noted that investors also can’t afford to overlook the potential longer-term impacts of fiscal interventions.
‘The question is whether all this stimulus will cause inflation to pick up down the road,’ said Desai. ‘Over the next couple of quarters, I am not overly concerned about inflation. After that, I think all bets are off.
‘This is not a prolonged depression where we would typically see deflation. We are seeing a trend of re-shoring of production—bringing manufacturing back to one’s home country—particularly production of goods related to the health care and technology sectors. The reason companies outsource in the first place is to reduce costs. When they bring it back home, costs will rise and we may have an inflationary impact down the line.
‘On top of that, we are going to come out of this crisis period with a massive monetary overhang, massively easy fiscal policy, some reduction to potential supply because of weak investment, and more stringent protectionist barriers,’ she added. ‘As such, it is very hard for me to see a scenario where we do not see some pick-up in inflation. For that reason, I think Treasury inflation-protected securities could offer good value over the medium term.’
For equity investors, the big question is how sustainable the current disconnect between the stock markets the economic reality can be.
‘Stock prices remain elevated despite economic data indicating deep economic harm,’ said Stephen Dover, head of equities at Franklin Templeton. ‘The fiscal, monetary, and political responses to the crisis globally have led to a world awash with liquidity and short-term fiscal stimulation. Much of that liquidity has gone into the stock markets, explaining a great deal of the markets’ ascent.
‘The key question looking ahead is whether the stock markets will continue to climb based on monetary and fiscal responses or whether something could make equity markets unwind.
‘Typically, bear markets happen when there is monetary tightening—I think that is unlikely to happen,’ he said. ‘This time around, the negative catalyst could be economic disappointments relative to expectations for a sharp, “V-shaped” recovery. I continue to believe that stock market and economic fundamentals will not remain disconnected forever.’