Changing the narrative

Will we see “lower for longer” or something new?

In my Monthly Letter last June, I talked about Nobel laureate Robert Shiller’s concept of “narrative economics,” and the idea that the stories we tell ourselves drive economies and markets. Understanding this concept was vital to successfully navigating markets over the past year, and we think it will be equally crucial in the post-COVID-19 world.

Most of the last decade has been dominated by the narrative of “lower for longer”— low growth, low inflation, and low rates. Now, as vaccination programs advance and fiscal policy agendas take shape, many investors are starting to consider which story will shape economies and markets in the future. Will it be more “lower for longer,” or something new?

In this letter, we consider three narratives that could take hold in the years to come: a continuation of “lower for longer”; a “Roaring 20s” scenario marked by higher economic growth combined with moderately higher inflation and interest rates; and “stagflation-lite,” in which inflation runs too hot, requiring much higher policy rates, stifling growth.

We think that both the “lower-for-longer” and “Roaring 20s” scenarios, and some versions of “stagflation-lite,” should prove supportive of risky assets over the long term, with either aggressive monetary or fiscal policy doing the heavy lifting. Against this backdrop, we think the default position for long-term investors should be to stay pro-risk and to stay invested. We like small-caps, financials, energy stocks, commodities, and emerging markets, as well as US senior loans relative to government bonds.

At the same time, we have to acknowledge that after such a strong start to the year, more good news is getting priced in, and we are entering a time of year when stocks have historically found it more challenging to advance. We should expect volatility. Recent months have also shown that, as the COVID-19 recovery narratives unfold, rotations within the market can be sharp.

While we can’t control what story the market believes on any given day, we can keep control of our own wealth story. That means it’s an opportune time to: 1) revisit long-term financial plans. Our Liquidity. Longevity. Legacy. approach can help align financial goals with investments and help put short-term volatility in context; 2) diversify across key themes, regions, and asset classes, including alternatives. A ‘barbell’ approach of reflation trades and structural growth can help avoid being caught on the wrong side of rotation trades, as market narratives shift; and 3) consider utilizing volatility to invest, diversify, and protect. In particular, investors should review whether using options could provide more favorable payoff structures than direct exposure.

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