In neuroscience, the brain makes sense of the outside world through a series of “spikes” in neural activity, known as a “spike train.” In the months ahead, investors will have their own “spike train” to follow. The challenge will be to focus on the bigger picture and not get “derailed.”
- Spike 1: Hospitalizations. Over the past year, both policymakers and financial markets have faced sudden spikes in coronavirus cases and hospitalization rates. But now that vaccination programs are rolling out, spikes in hospitalizations may be a thing of the past. Economic normalization could arrive sooner than we think.
- Spike 2: Stimulus. On top of resurgent consumer and business demand as lockdowns are lifted, we are likely to experience a further spike in economic stimulus as the US moves closer to another record-breaking fiscal package. Further procyclical stimulus presents upside risk to economic growth and corporate earnings estimates.
- Spike 3: Inflation. As pent-up demand meets constrained supply, inflation may, at least in the short term, spike higher. Shipping, food, and semiconductor prices suggest this is already happening in parts of the economy. While it may be brief, this period of elevated inflation will require investors and policymakers to hold their nerve.
- Spike 4: Volatility. Changes in all of these key variables will lead to periodic spikes in volatility. Last month’s moves among heavily shorted stocks are just one example of how volatility can increase suddenly. We see elevated volatility as an opportunity to generate yield, take on asymmetric exposure, benefit from market dispersion, or build up longer-term positions.
Overall, we retain a favorable view of markets over our tactical investment horizon. While the “spike train” may lead to volatility, we don’t think it will derail the bull market. However, the uncertainties around key market factors may cause some investors to abandon or defer their strategic plans. Investors looking to protect and grow their real wealth will need to have a plan to put their excess cash to work, and stick to it—particularly if this low-rate, rising-inflation, high-stimulus environment persists.
In terms of market positioning, to benefit from the likely upturn in global economic activity, we prefer emerging markets, and like small-caps over large-caps. We continue to monitor for opportunities to take advantage of elevated volatility, particularly in US equities, as dislocations emerge. Tighter credit spreads mean we see better risk-adjusted returns in equities rather than credit overall, and shift our preference for US dollar-denominated emerging market sovereign bonds to neutral. But with the hunt for yield likely to remain intense amid low interest rates, we continue to see scope for positive returns in riskier credit segments.