Too much of a good thing?

Is the US stimulus a boon or bust?

12 March 2021

1 minute read

Our Chief Investment Officer talks about market developments in February and what to expect from the month ahead.

The current landscape

February was another busy month with a notable drop in infection rates around the world suggesting a potential return to normality sooner than expected. Meanwhile, expectations for further government stimulus and support around the world – and particularly in the US – continued to evolve.

The recent surge in demand for commodities suggests that the global economy is in better shape than initially feared. Meanwhile, supply bottlenecks and the build-up of disincentives to invest in actual supply create a helpful supply backdrop.

The sheer size of the latest US stimulus package concerns some economists with the prospect of a faster-than-expected recovery driving up inflationary pressures. This could be further exacerbated by increased production costs, as companies re-organise supply chains for resilience rather than lowest cost.

In terms of portfolio positioning, we have recently added to developed markets equities. This has been funded from our exposure to high yield bonds, as we believe there is a slightly better range of possibilities for stocks versus high yield at current levels.

Finally, a few takeaways from the Budget. From an investment perspective, we believe that the rise in corporation tax demonstrates that the UK has room to raise tax rates on corporate profits while maintaining a competitive tax rate within the OECD framework. Meanwhile, we note a new momentum in the shift towards taxing company revenues irrespective of the location of a company’s head office – a move welcomed by many to level the playing field.

As ever, we recommend investors get invested, stay invested and stay diversified.

Too much of a good thing?

As part of our aim to keep clients informed of our current investment views and how these themes are impacting your discretionary portfolios, Phil Attreed, Head of Investment Consulting, talks to Will Hobbs, Chief Investment Officer, about market developments in February and what to expect from the month ahead.

Phil: Hello and welcome to the March episode of Monthly Market Insights. I’m Phil Attreed, Barclays' Head of Investment Consulting, and I’m joined by Will Hobbs, our Chief Investment Officer. We'll take a quick look back over the past month and also cover some of our thoughts on what to expect in the coming month of March. So, Will, when we look back over this last month, some of the themes I suppose have been a bit similar to last month actually: Bitcoin's still giving its disciples a pretty wild ride and the so-called reflation trade continues to grip investors as well. We've seen commodity markets outside of precious metals continuing with a pretty barnstorming start to the year actually, Will. And bond markets have started to struggle while stock markets continue to do pretty okay actually by all accounts. I guess the first thing for us to discuss is what's actually been driving all of that. We've seen some startling moves in the bond markets as we've mentioned in recent weeks so maybe start with that.

Will: It's another busy month I think, that much is pretty clear, and there's all sorts of things as usual that go into this. But there's a couple of things that really stand out, I think. One is the story with infection rates globally; so you have found in the last month or so in particular that infection rates around the world are dropping precipitously which is obviously very welcome. They're dropping so fast it's not really well explained by the progress of the vaccination campaigns or indeed estimations of pre-existing immunity but what is confusing scientists is being very welcomed by those looking at the economic outlook and trying to predict how well the economy is going to do in the next 12 months, a slightly sooner back to normal idea. The other thing which is notable is the expectations with regards to government stimulus and government support around the world and particularly the US, that's obviously the most relevant for the world's economy and stock markets, given the size and relevance of the US economy. But there you are seeing expectations with regards to this incoming stimulus package evolve a little bit and also some expectations of building up a little bit about the infrastructure package that may be in its slipstream. Now that point about government support, you and I have talked about a lot on this medium and all the other stuff, on the Word on the Street, everywhere that we've done, that's a really distinguishing factor in this crisis response relative to those of yesteryear. It's the sheer muscularity of government responses around the world and that continues; you're seeing that in the Budget in the UK this week but in the US that's the one that people are really looking at the moment and we'll see more in the next couple of weeks. 

Phil: Quite. And so I mean with regards in particular to the bond markets what you're saying is really it's those markets and broader markets and assets pricing in new information around that pace of recovery that we've talked about before. As you say we'll come on to the UK Budget shortly but the commodity piece is particularly interesting because I mean we, as a house, have obviously added to commodities within our strategic our long-term asset allocation in portfolios earlier on this year, but probably for slightly different reasons. Is that right?

Will: Very different reasons! I mean this looks like astonishing prescience to shift a load of exposure into the best-performing asset class by a mile so far this year. But as you rightly point out that's the strategic asset allocation; that's very much an activity where we look to reshape the portfolios for the long term and so there you're not looking…you totally ignore stuff that might drive asset classes in the next six months say, and you're really focusing on the incentives, the available incentives, and the credibility of incentives for long-term ownership in things like stocks, bonds and diversified commodities and how they interact. And that really informs how you allocate and as it happens, the process and team and models allocated a lot more to commodities, which is a bit of luck, never goes amiss in investing. But tactically there is quite an interesting story with commodities at the moment. Looking at the commodity price surge there's a couple of things again that stick out. One: just as we were just talking about, the commodity markets are telling us that the global economy is in a better shape than was only recently feared so the demand story for a lot of these commodities is firmer than some had feared. The second point is that from the perspective of supply, and obviously this is another important driver with regards to commodity prices, that there are a number of areas where you're getting bottlenecks or the buildup of disincentives to invest in actual supply and you're seeing the results here or the activities of cartels particularly oil, that's been very important. So those things are creating quite helpful supply backdrop. Now some are also pointing out which I think is an interesting point in a way that if you look at this recession, it's really a shock to services not necessarily goods and actually you found that some consumption has been shifted as a result of the restrictions on movement and changed risk appetite. You found that a lot of consumption has been shifted away from services and into goods which is also seen quite positive for commodities. The other thing which I think is interesting, maybe only to people in financial markets, but it's the shape of the futures curve which is again it's quite a nerdy point this I guess and one really that only a certain types of investors will go for. But the futures curve tells you, basically is currently in backwardation in a lot of commodities and what that means is that the price curve is downward sloping. So if you buy a future, an oil future, as you roll up to the spot price as the future comes nearer you're actually dragged upwards to the spot price which gives you a positive yield and that is something that's also being very attractive in this moment for investors. There's a number of things going on; it's a very complicated story. It's not the same for each commodity and it's not the reason why we're strategically asset allocating to it but it's interesting all to the same.

Phil: Quite. And a lot of those factors though I think are maybe feeding some investor concerns around whether or not we're actually letting in some of this reflation, we're letting that inflation genie out of the bottle. What are your and the team's thoughts around inflation?

Will: Yes. I mean it's the perennial question. There may be something in that and I think there's a couple of things going on with this inflation story. We referred to that stimulus package. That's got some people concerned; essentially it's a complex economic argument again but there are some economists arguing that the size of the stimulus is bigger than the size of the hole in the economy. It's a dreadful oversimplification but hopefully it gives you some idea. So you're overfilling and therefore if you're getting the economy to go faster than it's meant to be going, you create those inflationary problems that people have long feared. They've not been around for some time, those problematic inflations, so that would be a new problem to have in a sense for many investors. The point I'd make on that or we'd make on that is that a lot of this stimulus package in the US: some of it is designed to taper as the economy recovers, so there's elements of unemployment support for instance, and some of it's just one-off which is less likely to really create an inflationary problem. So the example is the $1,400 tax rebates for instance. And also you could argue that the hole punched by this pandemic is conceivably larger than currently estimated. The other inflationary arguments I think are we'll find out a bit more but there's some who are arguing that the new world is going to see increased production costs and part of this is about people reorganising their supply chains for resilience rather than lowest cost and so that could create extra cost. To be honest I mean for here I think there's an interesting counter argument to make which is actually supply chains functioned pretty well in this crisis. I think we didn't find food supply interrupted too readily, I mean there was a moment wasn't there but it didn't really get too bad. And any PPE problems were more about stockpiling issues rather than supply chain issues. So and I’m not sure about the extent of supply chain reorganisation we're seeing just yet. So this is a wait-and-see and remember: keep a bit of humility in mind with inflation. We're terrible at forecasting, that's not just Barclays I’m afraid it's everybody, that's because the relationship between growth and inflation has always been an uneven one, always prone to defying textbooks, academics, and central bankers alike so keep an open mind. 

Phil: As always. And just touching back on those bond yields and the movements we've seen though. Such movements as we have seen in recent weeks they can largely be absorbed and have been absorbed largely by markets. But what does the investing world look like to you and the team, if we continue to see those yields rising to more normal levels? What does that mean for stocks and the equity market that has obviously done very well in recent months? What does it mean for the likes of Bitcoin as well, does that bubble pop?

Will: Glad you're calling it a bubble: you can now get all the online abuse that has been directed to me –

Phil: I’ve listened to you for far too long.

Will: Yes, I’ve got those words, planted them…So no, I think the point here is that with stocks specifically the relationship between interest rates and stocks is a complicated one. There's a lot of facile analysis or commentary that goes on that interest rates up, stock valuations down, that's not necessarily the case. ­It depends on the level they're coming from, going to, the pace at which interest rates are rising, if the forces that are driving interest rates higher are the same forces that could conceivably improve your corporate profits outlook, then there's an offsetting impact too. So this is a very complicated story and I think the point from me at the moment would be that, the point from us, the team, would be that interest rates are coming from a very low level. They are currently not at worrying levels from an equity valuation perspective. What I can imagine and there's not empirical support, it's a bit scratchy here to be honest, but I could imagine a world where higher interest rates would certainly force a different sector leadership story in the market based on a change in how future cash flows or the shape of future cash flows is valued in a higher interest rate environment. That could certainly change the types of sectors and stocks that there are on the leaderboard on a regular basis. So I think that's an invitation to diversify beyond those recent winners which we always bang on about as you know. With regards to Bitcoin, we've had this debate on here before which is really about: if interest rates on your safest possible assets, government bonds generally, lending to very big liquid governments tends to be a pretty safe activity not risk-free as they say but it's pretty safe, so if you are suddenly getting a positive yield after inflation from those types of assets then the reasons to own things like gold, which doesn't throw off a coupon or Bitcoin which doesn't too, they just get a bit less. I think and that could create a slightly more tricky environment for those types of assets I guess.

Phil: Great and with the context of all that we've just discussed it'd be good to know what the investment teams have been up to. The Asset Allocation Team last time we spoke was mostly in watch-and-wait mode, but I did see one new trade coming through over the course of the last month. Maybe a few comments on that?

Will: Sure. So that's more of a relative value trade so they've added to developed equities funding that addition from exposure to high-yield, so junk credit as it's sometimes called or used to be called before the rebranding. And the story here is really without getting too wonky about it, too nerdy about it, it's the team see a slightly better range of possibilities for stocks versus high yield at current levels and so they're exploiting that by exchanging a bit of one for a bit of the other. So, yes, it's just one of those little tweaks of the portfolio that hopes to add value over time. Like I say with these things, you're looking more to get more than 50% right and therefore add performance more often than not, that's the trick. It's a probabilities game quite a lot of the time.

Phil: That powering down of high yield exposure is something we've seen them do before when we've seen valuations look a little bit stretched in that space. Obviously this time continuing to see value as you say in the in the equity market in the more developed world. So one final point around the Budget this week. I think probably the point of most interest and we've discussed internally is that of the rising corporation taxation. What are your initial thoughts on that move and the wider implications for investors, possibly even globally?

Will: I think there was lots of interesting stuff in the Budget wasn't there? But I think from an investment perspective, I think you're right, it was the corporate tax rise that was probably most of interest to us in a way as investors. There are a few points to make. I think one that was made widely beforehand which is that the UK has room to raise tax rates on corporate profits without offsetting whilst maintaining a competitive tax rate within the OECD framework. The other thing to point out there I do think is that the story about competitive tax rates and making sure that you retain that competitive edge; it's not just about the level of tax I don't think. It's about having workforces available, it's about having the right legislation, the legal framework, the right institutional context, all those things. It's a much more complicated debate I think sometimes than it's boiled down to in some areas. The other point though I think which is interesting broader about a debate going on internationally about corporate taxation, which is really the idea that this has long been mooted about the idea that it's probably preferable in the modern era to try and tax company revenues or company activity rather than where that company chooses to put its head office. And that in a sense is a complicated story; there's lots of entrenched interests and so on so it's been a very thorny issue to try and get consensus on but it does seem like there's a bit more consensus forming on this story. So that's something to watch in the months and years ahead because in a way the hole punched in public finances by this crisis is forcing a new momentum into this debate about how to tax corporations and particularly multinational corporations. It's seen as an unfair advantage relative to you could have your local plumber suffering a higher tax rate than a multinational corporation which doesn't seem quite fair to most people.

Phil: Great thank you very much, Will, insightful as ever. Thank you also to our viewers and our listeners. If you would like to stay in touch with our thoughts over the course of the next month in between these videos, please do seek out our weekly podcast Word on the Street where we'll share more of our latest views on markets and various goings on. Otherwise we look forward to being back with you next month.

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