- Invesco experts map out scenarios to help guide asset allocation decisions
- “Outsized” policy response and vaccine rollout programs have a positive impact on recovery
- Inflation expected to rise but will receive downward pressure from innovation and demographics over the long term
- Volatility expected to decline across asset classes, with cyclicals expected to outperform
Dubai, United Arab Emirates -17June 2021
In their new Mid-Year Outlook, Invesco’s global market strategists and thought leaders sum up their expectations for key economic and market developments over the next few months, as well as their implications for asset classes. They believe that we are in the early stages of the economic cycle and note that, though GDP is rapidly recovering to its pre-pandemic peak, past cycles have shown growth can continue well beyond prior peaks.
To address the breadth of possibilities that lie ahead in the current environment, the Invesco experts provide a base case scenario which they consider highly probable, and two other, possible scenarios. “Mapping our three macro scenarios into a macro regime framework can help guide tactical asset allocation decisions and support the analysis of current developments with an historical perspective,” explains Dr Henning Stein, Global Head of Thought Leadership at Invesco.
In their base case scenario, the Invesco experts expect global growth to accelerate through the end of the first quarter of 2022 as economies reopen, and then decelerate but still remain well above trend. As spending increases, inflation should rise significantly, but the Invesco experts anticipate it will moderate to a rate faster than pre-crisis trends but not sufficient to induce action from central banks. Over the longer term, they expect demographics and innovation to place downward pressure on inflation.
A substantial factor in their assessment of the macro environment is the outsized policy response. “Countries across the globe have enacted large fiscal spending programs to carry economies through the virus, far surpassing the actions undertaken in the Global Financial Crisis (GFC). However, the amounts vary across regions, pointing to divergent growth,” notes Dr Stein. Bond yields are likely to rise with the rebound in economic growth and inflation following re-opening after the pandemic. However, the Fed’s new Flexible Average Inflation Targeting framework means that it is likely to hold back on rate hikes. This should limit the rise in bond yields and extend the growth recovery while resulting in dollar weakness in the near term, which, in turn, should benefit commodities.
Following its very effective vaccine rollout, the US is likely to take the lead in the global economic recovery as growth in China moderates. The UK and the Eurozone are likely to follow the US recovery, with emerging markets countries generally laggingbehind because of the obstacles they face vaccinating their respective populations. However, all are likely to participate in the strong recovery, just at a staggered pace, given the nature of the crisis and the recovery: highly effective vaccines, pent-up demand, elevated household savings in a number of countries, very accommodative monetary policy and substantial fiscal stimulus. It is worth noting that some developed countries are focused on utilising their fiscal stimulus to help create a more sustainable, inclusive and circular recovery.
The Invesco experts expect market volatility to decline across asset classes, with more cyclical regions, sectors and styles expected to outperform. With fiscal and monetary policy stimulus likely to continue to support risk assets, equities are expected to outperform fixed income. Within the equity asset class, the Invesco experts favour smaller-cap and value stocks as their regime framework indicates that size and value outperform when economies are in recovery. They expect emerging markets equities generally to outperform developed markets equities, driven by global growth, easy monetary conditions and a weakening dollar. However, Covid may require regional selection due to varying paces of vaccination.
Credit and high yield are expected to outperform sovereign debt. Fundamentals are positive and supportive for US and European high yield debt, but valuations are extremely tight, limiting the potential upside from spread tightening, and increasing the potential downside in a widening scenario. Bank loans are supported by the strong credit fundamentals and may benefit from rising rates given their floating interest rates.
In their base case scenario, the Invesco experts remain constructive on many private strategies positioned to take advantage of continued global economic opening. Some COVID-related market dislocations remain an opportunity in private sub-asset classes, including sectors of real estate and infrastructure. In the event of increased global inflation, the investment experts would favour floating rate private credit strategies as well as real asset strategies that often have revenues with imbedded inflationary linkage.
In contrast to most past cycles, the Invesco strategists see the tail risks as being higher and better defined than is usual in a recovery environment such as the post-GFC environment. The two key risks to their outlook are, firstly, a resurgence of the pandemic and variants that are not protected against by current vaccines and could therefore prevent full reopening, and, secondly, extensive policy measures resulting in rapid monetary growth and inflation.
While the spread of more powerful virus mutations would have a negative impact on economic growth globally, Dr Stein believes that the impact would not be nearly as dramatic as the initial wave of COVID-19 because economies have learned to adapt to lockdowns and other tools utilized to control the spread of the pandemic. “Much activity has moved online, and many services have not fully re-opened. Instead of another major downturn, the economic rebound would be restrained, probably requiring extended monetary and fiscal policy support,” he says. “Emerging market economies would likely be hit hardest due to relatively limited healthcare infrastructure as well as lower vaccination levels.”
In a scenario of a strong economic re-acceleration accompanied by a more persistent rise in inflation, the Invesco experts would expect the Fed to initially delay responding, deliberately staying ‘behind the curve’. However, as inflation overshoots central bank targets globally, the Fed and other central banks would be forced to tighten more aggressively than markets anticipated. This would temper economic growth and have a significant impact on capital markets.