What’s hot and what's not as stimulus tapers off?
Last year brought fiscal stimulus to the world's economy at a scale never seen before. In Australia alone, the government spent $257 billion in direct economic support in 2020, according to numbers from KPMG. And that was before this year's lockdowns.
But after any wild party, there's a hangover. As the stimulus tapers off and normality begins to return (apart from our friends stuck in Sydney's lockdown), many investors are now asking themselves what that means for equities, bonds, and other asset classes.
In light of this, for the final part of this three-part series, we asked several contributors which investments they believe will benefit in this environment. We also asked them which they expect to lag the pack.
Responses come from:
Damien Klassen, head of investments at Nucleus Wealth.
- Tim Toohey, head of macro and strategy, Yarra Capital Management.
John Abernethy, chairman, Clime Investment Management.
“Recent winners are those most at risk”
Damien Klassen, Nucleus Wealth
The stocks we are looking at are similar to the winners from mid-2020: quality growth (think profitable technology) and defensive. In effect it is a barbell portfolio containing part:
- Defensive stocks that are interest-rate sensitive. In other words, stocks whose valuations will benefit from lower interest rates
- Quality growth stocks. In a low growth world, these are stocks that can grow considerably above-trend become more attractive
At some stage, travel stocks are going to go through their own inventory super-cycle. But you might need to be patient on this trade.
If you were looking for maximum returns, you might buy "junk" Growth stocks, companies with little to no earnings that often perform best in this type of environment. But we look at our portfolios differently. Risk is an important factor, and the junk Growth stocks are far from cheap and have as much downside as upside.
The recent winners are those areas most at risk, particularly Value stocks, cyclicals, resources and banks. We believe the recent inflation impulse will fade (see our inflation series for more detail). Manufacturing stocks have benefited as consumers haven't been able to spend on services due to virus constraints. This will reverse as vaccination rates increase.
Chinese growth is a major consideration. Debt growth has slowed considerably, and a broad range of measures are rolling over. There is a reasonable risk case that current conditions morph into a 2015-style Chinese slowdown which saw commodity prices tumble more than 50% and share prices dip between 10% and 15%. I'm much more comfortable owning Quality stocks in that type of environment.
Why another stock market draw-down is likely
Tim Toohey, Yarra Capital
Typically, it depends on why stimulus is being removed. For fiscal policy, the stimulus was always designed to be short term and temporary, in order to see out the worst of the mandated COVID shutdowns. So, removing fiscal stimulus is by definition a relatively early cycle development. Under this scenario, the economy is still benefiting from the fiscal stimulus and capturing operating leverage as spare capacity is absorbed.
Our preferred equity market positions in this case are companies with strong cyclical exposures. Within fixed income, curve steepening and credit exposures are favoured.
What does this mean? For stocks, companies with pricing power and sustainable cash flows should be preferred over long duration exposures.
We believe markets are transitioning from the end of the fiscal inspired cyclical trade to the start of the monetary tightening phase. There is ample scope for policy miscommunication, misjudgements, economic surprises and risk reduction during the twilight of this transition period. Call it a taper tantrum if you like, but we would be surprised if we transition to the tightening of monetary policy and avoid an old-fashioned equity market drawdown during the process.
Within fixed income, curve flattening trades would be favoured and in Australia’s case, we’re taking care in positioning for "carry and roll" strategies beyond the three-year point of the curve. (“Carry and roll” here refers to positioning a credit portfolio’s duration characteristics based on an assumption that the current yield curve is a good predictor of the future yield curve).
Monetary stimulus is here to stay
John Abernethy, Clime Investment Management
I would suggest that an economic recovery is well underway once emergency stimulus (fiscal) is withdrawn. Once we reach this point, most sectors of the economy – and the businesses that operate inside them – no longer need support as they are operating under their own economic or business momentum. So, I would be careful and not assume a dramatic change in the outlook for most companies.
While fiscal stimulus kept some average businesses operating – through measures such as cashflow bonuses and job support – they remain average businesses. We know that good businesses also benefited from support, so the listed companies most at risk are the poor businesses that survived. But such companies are always at risk operationally. The heightened risk for these companies is the return to facing their markets without fiscal support. A lot of these companies or entities are small and private.
My comments above are focused on fiscal stimulus. It’s even more interesting to consider monetary stimulus – negative real interest rates, quantitative easing and bank funding support.
While I don’t see monetary support waning over the next year or so, I believe that if interest rates are drawn level with or above the inflation rate (and they won’t be), then all risk/growth assets will be devalued.
If the banks had to finance their loan books at market rates – without RBA support – then the flow-on effect to borrowers would be acute.
To summarise, I’m more concerned about the withdrawal of emergency monetary support/stimulus than fiscal support. If monetary support stimulus is withdrawn, then chaos will ensue across all asset markets – so monetary stimulus won’t be withdrawn!
For stock investors, our contributors are united in their view that Quality - or at least, the Quality end of the Growth spectrum - is where investors should be positioned for the next year or two. And where they've discussed fixed income, it's also those assets with the longer-duration, more defensive characteristics that hold the greatest appeal.
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And you can follow my profile to stay up to date with the rest of this series as it's published. In part one, our contributors outlined which macro forces to focus on in the next year or two; and in part two, our contributors tipped which assets they expect to win (and lose) as massive stimulus unwinds.
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6 contributors mentioned
Glenn Freeman is a content editor at Livewire Markets. He has around 10 years’ experience in financial services writing and editing, most recently with Morningstar Australia. Glenn’s journalistic experience also spans broader areas of business...