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Investment strategy
July 23, 2021
3 mins

Unfinished pandemic, unfinished recovery

July 23, 2021
3 mins
Steven Wieting
Chief Investment Strategist & Chief Economist
SUMMARY

News from the UK suggests a coming surge of delta-COVID in highly vaccinated economies. This will set back the time frame for global reopening beyond our prior assumptions, into 2022.


For the world economy and markets, we’d characterize the likely impact as “disappointment” rather than “shock.” Authorities will manage the virus with widely different approaches in each country and region. It will lengthen the duration of COVID distortions to sectors, lengthening the depression of international travel.

Notably, the spread of the delta variant in India was extremely rapid and so was its retreat, largely over two months’ time. The most effective vaccinations might only slow the spread, but they do greatly reduce the severity of health impacts. The world economy isn’t positioned in the same way when it was shocked with the unknown in 1Q 2020.

Excess demand for goods and some services is draining limited supplies. This is not the backdrop for a contraction in industrial production, trade and employment overall. “Surprise” is a key element of shocks. Producers and market participants had no idea of the COVID demand impact when it first struck. A more limited economic impact is likely now with “social close” travel and hospitality industries likely to see a “double dip” contraction in some regions. In others, they may simply fail to fully rebound.

Co-existing with COVID

While we expect the global economic recovery will proceed and co-exist with COVID, asset prices are elevated relative to when the pandemic first hit. Until the world sees full, effective vaccinations or “herd immunity,” the likely new global COVID surge will promote dispersion of asset prices and dampen “mean reversion.” It has already dropped Fed tightening expectations by 40 basis points, spurring a rally in long-term safe haven bonds.

Like all other past health crises, COVID is not unstoppable. However, the longer it persists, the greater “inertia” will build to create lasting impact. A COVID setback will lengthen the period of unusually accommodative monetary policy. When the Fed ultimately raises interest rates, it will be at least marginally later in the economic expansion. This poses somewhat greater risk, and is itself a reason why long-duration, high quality bond yields will rise less than previously assumed.

Bond valuations are still unappealing for reallocation, with US real yields falling back to a cycle low -1%. However, we remain fully allocated to US bonds with 10-year US Treasuries roughly equal to the global average yield. This includes sub-investment grade debt and many other low quality sovereign borrowers. We continue to express our -8% underweight in bonds and cash in Europe and Japan.

With our previous views of the maturation of the market recovery, we reduced allocations to Brazil and Global REITs, reinvesting in US large caps and China shares. The later have underperformed by 23 percentage points since we reduced our weighting in January. We also shift 10% of recommended portfolios into global dividend growth strategies to raise portfolio quality and reduce risk within equities.

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