Investment strategy

June 13, 2021

The beginning of the end of easy money

June 13, 2021

David Bailin

Chief Investment Officer and Global Head of Investments

Steven Wieting

Chief Investment Strategist and Chief Economist

SUMMARY

The period of free money policy is coming to an end as the drop in US and global COVID infections suggests the time to give an early warning of tapering is now. Therefore, the very strongest equity market returns from the COVID crisis period may have passed. But we still urge investors to allocate for opportunities in the new post-COVID economy that lies ahead.

The Federal Reserve has said it wants to give markets a warning “well ahead” of any change in the pace of its bond purchases. It said the timing would depend on the economy returning to a state consistent with the Fed’s “long run goals.” From a macro perspective, the present pace of US job growth is rapid enough to restore the pre-pandemic unemployment rate in just 16 months, even if the 3.5 million sidelined by COVID rejoin the labor force.

Reacting calmly to another month of surging US consumer prices, investors seem to be strengthening their understanding of the immediate drivers of demand-driven, short term inflation. This was evident in the market’s calmer reaction to the large US CPI gain reported last week compared to their reaction to similar news a month earlier.

The COVID-bound economy has seen record swings in demand from sector to sector of a scope that no producer could properly foresee or manage. Of course, not all elements of the inflation outlook are transitory. If central banks and fiscal policymakers persist with the same strong stimulus in the post-COVID economy, lasting inflation will result. We think it is highly unlikely that they would do so.

It is worth noting the lessons from the period following the 2013 “taper tantrum.” The Fed spent five years tightening policy from 2014-2018. The Fed raised short-term interest rates nine times and shank its outstanding credit by a peak of $750 billion. In the same period, US equity total returns annualized 11%, inclusive of a near 20% drop at the end of 2018. But owing in part to a surge in the US dollar, non-US equities valuations have remained lower to this day.

In summation, the period of “free money policy” is coming to an end and the very strongest returns from the crisis period have passed. Looking across both collapses and rebounds, mid-cycle equity returns have differed little from overall long-term returns. After a 43% gain from a depressed period one year-ago, we would argue that multi-year returns will be lower looking ahead, but still rewarding.

CIO Strategy Bulletin (PDF 1.47 MB)

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The beginning of the end of easy money

SUMMARY

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