In this article exactly one year ago, we wrote about Nobel Prize-winning economist Robert Shiller’s concept of “narrative economics.” Shiller believes the stories we tell ourselves can drive economies and markets far more than any economic statistics.
Today, when investors are left to contend with an invisible virus and distorted data, the story is everything. Markets are faced with at least three evolving narratives: the “Fed” story, the “second wave” story, and the “US election” story. But which narrative will prove most powerful, stable, and durable? While news headlines can make us think the second-wave and election stories are the biggest drivers for markets, it is the Fed story that will endure over the medium term. Against this backdrop, we think the most important thing an investor can do is to be invested, not sit on the sidelines. We are positive on the outlook for both equities and credit. The naked truth is that the Federal Reserve has never been more explicit with its intentions. It is not focused on the theoretical, long-term political or economic consequences of its drive to loosen financial conditions. It intends to use its powers to help ordinary workers, fully expecting that it will also benefit owners of capital. Indeed, Fed Chair Jerome Powell may even think that efforts to loosen financial conditions will increase inequality, provided the rising tide lifts all boats.
As he told the press last week: “Just the concept that we would hold back because we think asset prices are too high…what would happen to the people we’re actually, legally supposed to be serving? We’re supposed to be pursuing maximum employment and stable prices and that’s what we’re pursuing...We’re not even thinking about thinking about raising rates.”
The two other narratives—centered around a second wave of the virus and the US election—will create volatility as headlines feed investors’ hopes and fears about the speed and strength of the economic recovery. But ultimately we think the Fed’s efforts will continue to support capital in risk assets. To borrow a phrase from Theodore Roosevelt, the Fed “speaks softly but carries a big stick.”
We believe these evolving narratives create opportunities for investors. The Fed story should be supportive of equities and credit such as USD and Asian high yield bonds, hard-currency emerging market sovereign bonds, as well as private credit strategies. Should fears of a second-wave story prove overblown, it will support recovery plays including US mid-caps, the UK and German markets, and stocks geared toward a reopening of the economy. Finally, the US election story is likely to cause volatility leading up to the November vote as markets weigh the prospects of additional fiscal stimulus against the potential for higher taxes and increased regulation. However, the election also provides additional insurance that the Fed won’t hike rates and that both political parties are likely to support further stimulus into the election.