Imagine you’re driving a car. You shift into a higher gear and accelerate, but then you see a speedbump and hit the brakes. If you focus just on what’s in front, it’s hard to pick up speed or work out how fast you’re going. When thinking about the macroeconomic outlook, conventional wisdom suggests it’s difficult to see very far into the distance with any clarity, and there are plenty of things that are still very uncertain today. For example, can the US election result really bring about sufficient stimulus or will political gridlock prevail? When will an effective Covid-19 vaccine be distributed on a mass scale?

The world is an uncertain place. However, we’re confident that things are going to get better. We are more bullish than the consensus and believe risk assets – such as equities and corporate bonds – will perform well during 2021. Over the medium term, the recovery is likely to become more self-sustained, owing largely to the extra fuel of policy stimulus, which will allow the economy to move into the fast lane and reach escape velocity. We are also optimistic that an effective vaccination programme will allow our economy to reopen more fully – bringing more cars back onto the recovery highway.

The Covid-19 recession is sharper and shorter than those in previous cycles because it’s the first ever downturn by decree. When economies have reopened, activity has bounced back much more quickly than in recessions triggered by policy tightening and balance-sheet repair. One of our key assumptions in our forecasts is that policymakers in countries hard hit by the virus will continue to do all they can to replace the loss of private sector income from lockdowns through substantial wage subsidies, unemployment benefits and other fiscal transfers. While this means even higher debt, governments can afford to spend heavily if central banks keep the liquidity taps open, to anchor real rates at rock bottom.

The availability of effective vaccines should be followed by the rapid immunisation of high-risk groups, including the elderly, those with existing health problems and healthcare workers. Following this phase, vaccines should begin to be distributed more widely, perhaps as soon as the second quarter of 2021. This progress would mean a lot of spare capacity could be put to use as the economy starts to pick up again. We expect activity to remain subdued this winter, but to rebound in the spring, when we’ll be in the early stage of a new cycle.

It’s not too early to invest in the early phase of the cycle

Assets geared to accelerating growth should benefit during the early phase of the cycle. Specifically, equities and higher-risk credit should outperform high-quality bonds. As safe-haven assets lose their appeal, the US dollar should weaken further, which is likely to benefit emerging markets. Gold, another portfolio diversifier, also tends to lose some of its shine in the early phase of the cycle. Our current tactical asset allocation positions reflect the overall risk-on theme.

Demand for smaller and more cyclical businesses is likely to strengthen, while the discount for lower-quality companies will probably drift lower. To further strengthen our conviction, we’ll be looking for more evidence that a safe and effective vaccine is being rolled out according to our expectations. We’ll also keep an eye on whether Covid-19 infection rates fall at the pace we envisage, facilitating a rise in activity during the second quarter. In addition, we’ll be tracking whether macroeconomic data picks up to match what we project in our base case.

Central banks are likely to keep real rates at rock bottom

Moving into the early stage of a new cycle typically means rising yields and steeper curves. Yet unlike past cycles, central banks are unlikely to tighten policy anytime soon due to high levels of debt and an ongoing need for stimulus, along with below-target inflation levels. While they won’t suppress each and every small increase in interest rates, they’ll probably continue to make funding very affordable for governments and the private sector. Nominal yields should rise slightly in the US and not increase much in Europe. Meanwhile, inflation and inflation expectations should pick up in the US more than Europe, keeping real rates at or close to record lows.

Source: Bloomberg

Real and nominal yields are extremely low

Low real rates mean that the discount rate applied to risk assets is lower than in past cycles, so equities and higher-yielding credit should be well supported. Within equities, growth stocks such as those in the tech sector tend to be particularly sensitive to interest rate movements. This means that early phase of the cycle could bring investment opportunities in areas that are more strongly linked to improving economic activity, such as value stocks. However, this doesn’t mean that it should be a negative environment for growth stocks, especially considering that, over the medium term, they are likely to continue to benefit from very low interest rates in real terms.

The combination of early-cycle dynamics and rock-bottom real rates could also trigger a rotation within the tech sector, with investors looking to gain further exposure to more cyclical subsectors. In addition, low rates mean that investing in private assets could enhance overall returns due to the relatively low expected returns from public markets. These opportunities could include private equity, private credit, venture capital, and the intersection of sustainability themes with infrastructure and property. Hedge fund-based multi-strategies are likely to be a return enhancer too.

Coordinated fiscal and monetary policy is likely to play an even greater role

Unlike past cycles, governments are unlikely to introduce significant austerity measures during the early stage of the new cycle. Covid-19 triggered the first ever recession by decree through widespread lockdowns. With funding costs kept at very low levels by central banks, fiscal authorities will be able to raise more debt and spend more aggressively to jump start the economy when reopening becomes possible on a larger scale.

Source: Quintet, national governments and central banks

Fiscal & Monetary Easing (% of GDP)

Governments and central banks are pulling out all the stops to support their economies

+ 150 bps of rate cuts

+ 65 bps of rate cuts

Fiscal authorities are likely to increase borrowing to stimulate the economy on an ongoing basis, as in the US, which is dollar-negative through larger twin deficits in its fiscal and trade balances. They’re also likely to create a new safe asset, such as Europe’s recovery fund, to finance extra public spending and investment backed by joint-debt issuance. By paving the way for additional fiscal integration, this recovery fund should lead to an appreciation of the euro versus the dollar and on a trade-weighted basis. Overall, governments are likely to intervene much more actively across sectors by becoming bigger employers and spenders globally.

By keeping the liquidity taps wide open, corporate default rates shouldn’t spike as much as in past cycles, supporting lower-quality, high-yield credit. This should also support a recovery in distressed sectors, and leave the economy less structurally impaired than previously thought given the magnitude of the Covid-19 shock.

The major economies should become more self-reliant

Following Joe Biden’s victory in the presidential election, the relationship between the US and China isn’t likely to change much, but the communication style between both countries should improve. China’s five-year plan mostly talks about moving away from exports and into domestic demand by shifting from manufacturing and into services. Even within manufacturing, the idea is to build more self-contained supply chains. As a result, the US and China are likely to decouple over time by becoming more autonomous. Similar shifts are also happening around the world. Leaders from 15 Asia-Pacific countries, including China, Japan and South Korea, have signed the Regional Comprehensive Economic Partnership (RCEP) trade deal, while Europe is starting a new wave of economic integration.

The prominence of regional blocks – as opposed to one global economy – is likely to rise over the next 10 years, and the importance of emerging markets is also likely to increase.

As a result, there should be new investment and diversification opportunities across geographies, which are likely to play out over many years. As the investment universe expands and major economies decouple, portfolio diversification is likely to become even more important. The only way to gain exposure to the world economy is to invest globally, and there are attractive opportunities across all regions.

Sustainability is likely to be at the heart of structural change

The US is likely to re-engage in the fight against climate change under Joe Biden’s leadership, who has already pledged to re-join the Paris Agreement. He’s also outlined a green investment agenda that aims for the US to achieve a 100% clean energy economy and reach net-zero emissions by 2050. China has also committed to achieve climate neutrality before 2060, and the EU’s recovery fund is making climate change policy a key focus too.

Sustainability is becoming a dominant investment concept, and markets for green assets are set to grow in size and scope. In addition, technological themes are likely to overlap with environmental ones and government policies should take this into account. This shift is why many of our investment themes focus on sustainability. Taking climate change as an example, our work highlights opportunities in low-carbon equities and green bonds, as well as the value of verified emission certificates.

While we may have hit a temporary speed bump, it’s important to remain focused on your final destination as the global economy gets back on track. A safe and effective vaccine should remove many of the barriers that have been so devastating throughout 2020, and policymakers are likely to continue to provide support. We’re confident about the outlook, which is why our portfolios favour investments that tend to benefit during the early phases of the cycle.

Investment returns are often stronger when the economy is weak but improving than when it’s strong but deteriorating

We stay invested for the longer term – If you had missed the 10 best days in each decade your returns would be substantially lower

Source: Quintet, FactSet

Source: Quintet, IFO, FactSet

We expect the global economy to return to growth in 2021 

Europe, Asia and the Americas trade more within their own regions than with the rest of the world

Source: United Nations Conference on Trade and Development

More than 50% of the EU’s long-term budget (incl NextGeneration EU) will support modernization and the transition to a sustainable economy

Source: Quintet, European Commission