However, the portfolio management team here at Dorval Asset Management, an affiliate of Natixis Investment Managers, notes that the economy is soon set to hit its point of peak acceleration. Additionally, the recovery is broadly priced in, probably bar services sector activities, such as tourism, banks and transport, which have been the most directly hampered by the Covid-19 crisis. Yet the overall situation remains broadly upbeat.
Peak of economic acceleration approaching, but unprecedented growth sources are firming up
The recovery in 2009/10 gave way to a phase of pedestrian growth, yet the second phase of the cycle currently kicking off has a greater chance of setting growth at a fairly dynamic cruising speed, with unprecedented growth sources still lying ahead:
Wider global roll-out of the vaccination program is poised to dampen the risk of disruption in production chains and prop up world trade, as well as tourism over the quarters ahead. This holds true in both developed markets in Asia-Pacific – such as Japan and Australia – where the vaccination program got off to a late start, and emerging markets.
Households in developed countries are emerging from the crisis in remarkably solid financial shape on the back of support policies. The reserve of savings built up during the crisis along with wealth effects are set to shore up demand for quite some time.
Massive investment programs are also poised to drive growth, with the initial amounts from the €750bn plan in Europe (4.5% of EU GDP) to be paid out from July 2021. This plan will first and foremost benefit southern and eastern European countries, buoying the risk profile for the continent that still bears the scars of the euro crisis and Brexit. Meanwhile in the United States, a similar program should be waved through before the end of the year. These plans’ multiplier effects are a subject for debate, but in our view, they will definitely have a positive impact on growth over the years ahead.
The central banks have made their choice between two possible risks
Bottlenecks, longer delivery times and labor shortages have pushed down production – for example in the automotive sector – and fueled significant price hikes over the past several weeks. But the central banks have picked their side, as they opt to ward off the specter of renewed sluggish inflation at a later date (once the transition is complete) rather than push back against the menace of excessively high inflation.
The central banks’ strategic goal is still to re-anchor long-term inflation projections at a loftier point than over recent years. They will therefore maintain extremely favorable monetary conditions, with a record differential between interest rates and the economy’s nominal pace of growth. However, long-term yields are still set to edge up gradually if reflationary policies produce the desired effects – as we tend to think they will. This success will be measurable first and foremost on the job market: unemployment at around 4% in the United States (vs. 5.8% in May 2021) would likely prompt the Fed to cautiously start tapering its asset purchases.
Reflation will have to combine with sustainability goals
Joe Biden’s election as president stepped up the trend in support of more ecologically and socially sustainable growth in the minds of many. Everyone – or almost everyone – seems to agree that they need to do “better” (greener, more efficient, more inclusive), but the debate rages on between those in favor of “more and better” growth and those who advocate a “less and better” approach that they feel is crucial to save the planet.
The hefty investment programs announced clearly fit with the “more and better” option, as they combine more growth with the transition to a low-carbon economy. However, other measures – carbon taxes, restrictions, regulation, etc. – could push in the opposite direction.
Governance is the key to adaptation
In a world where macroeconomic reflation and sustainability requirements are set to combine – but also sometimes collide – companies will need to adapt if they are to keep up. Businesses that succeed in adjusting will enjoy fresh opportunities while cutting back their risks, especially in terms of controversies. Adopting more robust governance, for example with greater diversity of expertise and background on boards of directors along with these bodies’ independence, will be one of the key prerequisites for successfully staging this shift. Dorval Asset Management’s SRI approach therefore focuses its portfolios on corporations that take a responsible approach in this arena.
Equity markets correctly valued but fairly strong opportunities remain
Massive support along with investor risk appetite have considerably pushed up valuations on the equity markets, yet demanding valuations do seem to fit with the overall environment comprising an economic recovery and negative real rates. The equity markets maintain an attractive risk premium in comparison with bonds or even city real estate. Additionally, the prospects of a gradual surge in long-term yields and therefore capital losses on bonds, advocate for a focus on the equity markets for wealth preservation strategies. In Dorval Asset Management’s global funds, net bond exposure has involved zero duration since the start of the year.
However, as suggested by the extent of cyclical stocks’ outperformance vs. defensives over the past several months, the rerating process for stock-market assets – a characteristic feature of the beginning of the economic cycle – is mature. Against this backdrop, the portfolio management team’s allocation will likely take a less offensive approach on average over the second half of the year.
In the current environment, Dorval Asset Management focuses on themes related to the extension of growth (small- and mid-caps, sector diversification), companies and industries that fit with the “more and better” approach of green stimulus programs, and stocks that still harbor potential to benefit from an eventually Covid-free world i.e. tourism, banks, etc.