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July 9, 2019

In conclusion

This expansion is different in its nature (demograph­ics, indebtedness, productivity, populism, politics, geopolitics) and in the degree of public intervention required to bring it to its potential. It is tempting to worry about Trump’s U.S.A., a major breakdown of U.S.-China negotiations, geopolitical tensions and – why not? – secular stagnation.

The global economy, stimulated by highly accom­mo­dative public action, will continue to expand at a moderate pace in 2019 and 2020. That inflation has still not been stimulated to the target 2% in many in­dustrialized countries confirms that structural forces (demographics, debt, productivity) are still at work, that the neutral monetary policy rate is lower than central banks have estimated and that monetary policy requires more flexibility than usual.

It should be kept in mind that such flexibility could lead to speculative bubbles in assets and to finan­cial distortions, without stimulating inflation. If the mandate of central banks is economic growth, full employment and price stability, they’re almost there.

A 2% inflation target is all very well, but is it possible that talk of this target, which has been going on for decades now, has helped anchor price movements around the long-term expectation? What if the target were moved to 4%?

On one hand, central banks would need to explain the reasoning behind the new target to households, entrepreneurs and investors. Apart from the risk of damaging their reputations and credibility, they might have to wait a generation for the long-term expecta­tion to move from 2% to 4%.

On the other hand, if the central banks have been unable to move inflation to 2% after a decade of sus­tained and even experimental intervention, how can they move it to 4%? They have managed to restrain prices increases and modulate long-term expecta­tions, but for 10 years now they have been unable to move the needle lastingly upward.

In one proposal, governments could resort to “heli­copter money”. For example, each household could receive a $5,000 cheque for purchase of goods and services for 12 months. There is no doubt that such a move would create a consumption boom and drive up prices. But what would happen in the following year? Without another cheque, consumption and inflation would fall back down.

In short, there is no easy solution. We’ll have to get used to it: the expansion will continue at a moderate pace and will be uneven from country to country, just like inflation. Public action will remain accommodative for the rest of this expansion.

Which will be how long? Who really knows! For now, the great majority of indicators are upbeat. Our ill-understood economic cycle and our ill-loved invest­ment cycle will continue on their course. Geopolitics will bring disturbance and volatility, but if there is one thing the global powers that be agree on, it is con­tinuity of the expansion. If 2020 will be a key year for Donald Trump, so will 2020-21 for Xi Jinping.

Tactically, investor states of mind could continue to be influenced by desire to defend the gains of Q1 over the summer. Traders may well “sell in May and go away” this year if U.S.-China relations deteriorate further. Cash and bonds would stand out under such conditions. Absent an all-out crash, we would consid­er taking advantage of this overreaction to redeploy cash to equities.

Strategically, it’s too soon to go defensive in view of a cycle end. At this writing the expansion may not be perfect but is doing fairly well. For some, growth is too slow. Is that a reason to brace for a cycle end?

Of course not. Out to a 12- to 18-month horizon, we continue to recommend overweighting equities, un­derweighting bonds and neutral-weighting cash and alternative investments.

Is a total return exceeding 4% to 5% conceivable in 2019? Yes. It will come mainly from equities, whose backdrop is propitious for a return of about 7% including dividends, and to a lesser extent, tech­nically, from bonds if investors seek refuge from spikes of volatility and uncertainty. With economic growth and inflation exceeding expectations, a grad­ual moderate normalization of rates is conceivable.  Alternative investments will add to risk-adjusted re­turn, as will cash. Agility of execution will support the investment strategy and risk-adjusted total return.

Text taken from: Desjardins Securities, The Quarterly, Number 24, Summer 2019