Markets are sometimes perverse beasts, frequently fickle masters, often prone to knee-jerk reactions. At last week’s regular Federal Open Markets Committee (FOMC), the US Federal Reserve’s monetary policy committee, members talked about thinking about when the right time might be to begin tapering the current $120bn a month quantitative easing bond purchasing programme. They pondered whether interest rates might need to rise in 2023 rather than in 2024 as the nerves jangle about inflation.
Just consider that for a moment: “talked about thinking about…”, in essence, two steps away from actually doing anything at all, where decisive action would be the second derivative. Nevertheless, markets reacted sharply: economically sensitive equities fell; in fixed income, counterintuitively, bond yields fell as prices rose; the dollar went up in value.
Is this the end of the ‘reinflation trade’, the one in which ‘value’ companies have enjoyed seven months in the sunshine before being cast into the shadows once more, while ‘growth’ companies regain their almost unbroken position of dominance enjoyed for more than a decade?
Significant re-expansion followed by trend growth? Or something more?
From a macro-economic perspective, the position is far from clear-cut and binary. Certainly, the global economy is recovering from the trauma of 2020. The 2021 rate of ‘growth’ (more accurately ‘recovery’) is likely to be a record if global GDP expansion reaches the 6.5% consensus estimate, having declined by 3.6% last year. By the end of the first quarter, the US economy had already recovered all last year’s losses and surpassed its nominal value recorded in December 2019, even more remarkable for having been achieved with unemployment at over 5% rather than under 4% pre-Covid. During the last six months, the estimated date by which the UK economy should reattain pre-Covid levels has been brought forward by a year compared with the worst outlook being contemplated less than 12 months ago.
The longer-term question is what happens beyond the recovery phase, looking out towards 2025. Will the western world revert to long-term trend growth, roughly 2%-2.5% for the US, 1.5%-2% for the UK and roughly the same for the EU? This was the pattern for the post-Global Financial Crisis economy, the exception being China which although posting much the greatest growth rates of all the major economies, was gradually slowing from more than 7% and struggling to maintain 6% (which sceptics believed was a Chinese Communist Party propaganda figure in any case), not helped by the frictional costs of Trump’s trade war. Or is the newfound western addiction to a strong diet of Keynesian ideology and significant, even egregious government intervention through post-Covid recovery stimulus, infrastructure spending and the extensive programmes to decarbonise society likely to determine a different trajectory for long-term growth? This is where politics and the electoral cycle rather than merely economics become important factors.
“Events, dear boy, events….”
In the United States, exactly five months into Joe Biden’s presidency, already the political battle lines are being drawn for the mid-term congressional elections in November 2022. If you thought you had seen the last of him and despite there being no presidential election, be prepared for Donald Trump to be centre stage once more: The Donald is not finished with America; whether America is finally finished with The Donald remains to be seen.
In the meantime, even with a nominal clean sweep of the White House, the House and the Senate, Biden and his Treasury Secretary Janet Yellen, the arch-proponents of the “GO BIG!” economy, aided and abetted by veteran socialist Bernie Sanders, Chair of the powerful Senate Budget Committee, and a compliant Federal Reserve, are going to have to work hard to convince the more moderate among Democrat congressmen that the rapidly mounting level of national debt does not pose a systemic risk to the US economy. With the $1.9 trillion Covid recovery package already enacted, will time run out for the remaining $4 trillion of fiscal packages to be agreed? Markets are hedging their bets that either enough Democrats will lose their nerve and not endorse the measures in full, or that Biden loses control of one or other houses of Congress next year and significantly less than intended is achieved thereafter. While such an outcome would take some steam out of the economy, on the other hand it would also ease the pressure on inflation. Markets are finding it difficult to work out which matters more.
Meanwhile in Europe, political arguments with economic consequences are just as critical. The position is complicated, however, by the fact that while the 19 countries of the eurozone share a common currency, interest and exchange rate, they have no fiscal union; as for the remaining eight members of the EU, they have neither monetary nor fiscal union. And within the eurozone in the context of mutualised debt, repayment obligations and underwriting, despite the agreement to the pan-EU €750bn centralised Covid recovery package (yet to disburse its first euro cent) there remains a fundamental split in attitudes towards fiscal probity between the conservative north (including Germany, the Netherlands, Finland and Austria) and the perceived fiscally incontinent Club Med countries focused on France, Italy (perhaps new prime minister Mario Draghi will change that perception?), and Greece, Spain and Portugal. Adding more toxin to an already potent brew, the European Court of Justice is now proceeding against the supreme German court and its ruling last year on the virtual illegality of the European Central Bank’s QE policy. Do the various national and supra-national stimulus packages in the new post-Covid order have the long-term power to overcome the inertia of ingrained economic protectionism, a regulatory framework which stifles rather than champions free-market economics, and a debilitating decision-making process based on compromise and fudge and which relies on grinding the opposition into submission, all to produce above-trend growth?
As for the UK, exactly half-a-decade on from the Brexit referendum, and as the mid-July Covid Freedom Day beckons, the near-term growth prospects are likely to be determined by confidence in returning to normal activities unimpeded by Covid restrictions. The medium- and longer-term views are more likely to rely on the extent to which we grasp the opportunities for global trade mixed with the effectiveness and efficiency of government spending programmes at home, all within the constraints of national debt at 99% of GDP.
Memo to central banks: avoid painting oneself into a corner
It is a truism of forecasting that the further into the future the economic soothsayers predict, the more likely they are to be wrong. Against a dynamic backdrop with many moving parts and imponderables, have the major central banks been too prescriptive in their tautological ‘forward guidance’ predicting how long interest rates will remain static years into the future? And have markets been too literal in taking forward guidance at face value? The Fed especially, in a bid to calm market fears about incipient enduring inflation and economic volatility, had a public position of seeing effectively zero interest rates persisting until 2024; that position has now been revised to the possibility of two quarter-point rate rises in 2023 and with some FOMC members predicting the need to push rates higher as early as next year. There is also the need to begin re-building interest rate headroom to be able to deal with the next slow-down, the Fed explicitly having said that negative interest rates are to be avoided.
Debate is fierce as to what the future ‘neutral rate’ is likely to be (the rate of interest that neither stimulates the economy nor acts as a brake); the FOMC estimates that the longer-term neutral rate may be 2.5%, implying that the US economy is capable of sustaining real GDP growth at that level after allowing for inflation. The risk to that estimate is if structural inflation in excess of the Fed’s 2% target becomes embedded and enduring and an interest rate higher than 2.5% is required to prevent inflation spiralling out of control, an interest rate which would be being applied to a debt mountain currently larger than the value of the entire US economy. As we have discussed before, a pre-requisite of raising interest rates is the cessation of QE, itself a financial tightrope to walk if markets see their universal support mechanism being withdrawn.
Merlin: a foot in both camps
The Jupiter Merlin Portfolios are designed as one-stop investment solutions. Reflecting the uncertainties described above, we believe it is imprudent to take a binary stance in equities on ‘value’ versus ‘growth’, particularly when sentiment can flip on a sixpence. We prefer to have exposure across the spectrum of investment styles so we are not confronted with the all-on-black-or-all-on-red decisions of the roulette gambler when markets rotate from one style to the other. We nudge the tiller appropriately as required, prepared to take more significant action if an inflection point is reached, as was the case in November last year on the announcement of the successful Covid vaccine trials. As John Maynard Keynes said, “When the facts change, I change my mind. What do you do, sir?”. We do too.
The Jupiter Merlin Portfolios are long-term investments; they are certainly not immune from market volatility, but they are expected to be less volatile over time, commensurate with the risk tolerance of each. With liquidity uppermost in our mind, we seek to invest in funds run by experienced managers with a blend of styles but who share our core philosophy of trying to capture good performance in buoyant markets while minimising as far as possible the risk of losses in more challenging conditions.
The value of active minds – independent thinking:
A key feature of Jupiter’s investment approach is that we eschew the adoption of a house view, instead preferring to allow our specialist fund managers to formulate their own opinions on their asset class. As a result, it should be noted that any views expressed – including on matters relating to environmental, social and governance considerations – are those of the author(s), and may differ from views held by other Jupiter investment professionals.
Fund specific risks
The NURS Key Investor Information Document, Supplementary Information Document and Scheme Particulars are available from Jupiter on request. The Jupiter Merlin Conservative Portfolio can invest more than 35% of its value in securities issued or guaranteed by an EEA state. The Jupiter Merlin Income, Jupiter Merlin Balanced and Jupiter Merlin Conservative Portfolios’ expenses are charged to capital, which can reduce the potential for capital growth.