A year ago, the world was falling apart as the coronavirus started to spread around the globe. Stock markets sold off markedly amid turbulent volatility throughout the first quarter before reaching a nadir on March 23, 2020.
Our jobs as investment professionals not only entailed navigating this violent storm but also counselling our investors on the best way to protect and grow their wealth by committing to rational decision-making during a time when almost nothing in the world made sense.
While we could not be sure of the exact paths the markets would take to recovery, we were confident that our disciplined investment process would guide our investors through the massive pandemic driven sell-off.
A year later, investors with equity exposure and who didn’t panic have benefited handsomely. The stock markets continue to reach successive new highs, and signs that the global economy may recover more strongly this year than expected have added to positive investor sentiment.
Monetary and fiscal policies remain highly accommodative, with the US government signing off on a $1.9 trillion fiscal package. The trillions of dollars washing through the system have raised concerns that inflation may become a problem. As a result, financial markets have begun pricing in inflation and the expectation that central banks will be pressured to tighten monetary policy and raise interest rates earlier than expected.
Inflation concerns are likely the cause of a relatively steep recent rise in bond yields as investors have sold off nominal bonds in favour of other assets, like inflation-linked bonds, that offer better protection against inflation. However, central bankers have reasserted that they don’t expect inflation to become entrenched and that monetary policy will remain accommodative for years to come. US Federal Reserve chair Jerome Powell says there may be a rise in inflation in the short-term, but it is not likely to become troublesome.
Investors are moving into floating-rate bonds, among other strategies, to protect bond portfolios from inflation. Yields are rising, and bond prices are coming down, but the rates on floating rate debt will increase, which will help preserve value.
We’ve been in a declining rate environment for the better part of four decades. Bonds last came under significant pressure in 2013 when Ben Bernanke caused a taper tantrum by suggesting that the Fed could cut back on monetary stimulus. Concerns that markets may be facing another taper tantrum have been instrumental in the rising bond yields.
In 2013, when the market was anticipating a rise in interest rates, I argued that it was imperative that rates eventually rise because it was essential for the US economy’s longer-term financial health. I was somewhat wrong because rates did not rise as much as expected. And here we are again faced with another crisis which has led to more easy money policy. While there are predictions that rates will rise this time and that the 40-year bull markets in bonds will come to a halt, I cannot be certain about exactly when this will happen.
On the bright side for now, monetary and fiscal stimulus are expected to increase company earnings, which will better position them to repair their balance sheets. Credit risk could very well be lower in the high yield markets as the economy improves.
However, along with inflation, a huge concern is that asset prices are simply inflated due to the large amounts of stimulus. Some areas of the stock market, such as technology, are more frothy than the market as a whole. The values of technology stocks, and other companies with distant profitability, may be more susceptible to increasing interest rates because their far-off future earnings, if ever realized, are discounted more as rates go up.
However, with the signs of faster than expected growth and possible inflation, there was a sectoral rotation away from tech stocks and into cyclical and value stocks, including financial, health care and industrials shares, which should benefit from renewed economic momentum.
In the commodities sector, oil and copper prices have been the main beneficiaries of the expectation of normal economic times. On the other hand, Gold has failed to benefit from its usual prime position as an inflation hedge, falling below $1,800 an ounce after rising to more than $2,000 in 2020. Moreover, with bond yields rising, the opportunity cost of holding a precious metal that offers no yield has increased.
Emerging market assets have been adversely affected by inflation fears as investors retreat into US Treasuries, as risk-on turned into risk-off sentiment. Latin America has been particularly hard hit, with the Brazilian stock market declining 20% last year and experiencing further declines this year. In March, the stock market experienced its worst day since March last year when Petrobas CEO Roberto Castello Branco was ousted by Brazilian President Jair Bolsonaro after a spat over fuel prices. He was replaced by a retired army general with no oil and gas experience. Investors took fright over what they consider to be government interference and a potential reversal in the oil major’s shift away from politically-based policies over the past few years.
Brazil’s economy has also been extremely hard hit by the ongoing COVID-19 health crisis, with infections still rife and hospitals filled a year after the pandemic began. China has extended its support to the country, supplying COVID-fighting resources. However, the country’s economic plight has meant it has not been able to pay back loans extended by the Chinese government over the past decade.
The levels of indebtedness resulting from the crisis globally are cause for concern, given the lofty amounts of government debt that have been incurred to rescue economies. It is questionable about when and if governments will start reducing these debt burdens and what impact such actions could have on economies. Are we stuck in a global economy that will require continuously low rates and other stimulus measures to keep it from falling apart? We can’t be entirely sure how long this can continue and if this might all come crashing down.
Nonetheless, there are ways investors can position their portfolios to withstand a potential calamity. Just as following a disciplined investment process held investors in good stead during the most unsettling and uncertain 12 months after the pandemic began, so will it again, no matter what lies ahead.
Garnet O. Powell, MBA, CFA is the President & CEO of Allvista Investment Management Inc., a firm with a dedicated team of investment professionals that manage investment portfolios on behalf of individuals, corporations, and trusts to help them reach their investment goals. He has more than 20 years of experience in the financial markets and investing. He is also the Editor-in-Chief of the Canadian Wealth Advisors Network (CWAN) magazine. He can be reached at firstname.lastname@example.org