The writer is group chief investment officer at Amundi
Bond markets are firmly in the driving seat. Rising yields on the back of the accelerating economic recovery are signalling the revival of inflation. They will also spur the comeback of value investing.
For too long, inflation has disappeared from investors’ radar. So, it is tempting to view its recent uptick, mainly in the US, as a mere technical rebound in the price of food, oil and manufacturing inputs from their fall at the beginning of last year’s lockdowns. But investors would be wise to take this narrative with a pinch of salt.
This is because various structural forces may prove hugely consequential in hindsight. The key ones include a hostile environment for trade and globalisation, business and labour support public programmes and the extraordinary debt burden fuelled by the pandemic. These are set to create a turning point in the current market regime before long.
Most importantly, inflation is now desirable as the way out of the crisis by reducing the value of the debts over time. A year ago, central banks and governments were forced to take unprecedented measures in real time to avert a 1929-style depression. The resulting skyrocketing debt will doubtless weigh on future generations, but, for now, it seems the only game in town to reboot national economies by making them even more debt addicted.
For this entire house of cards not to crumble, growth and inflation need to be restored. It is the only way to repay the debt legacy of the crisis. That is precisely why the likes of US Treasury secretary, Janet Yellen, and Federal Reserve chair, Jay Powell, are playing down the significance of the recent awakening of inflation — but not for long.
As its vaccine programme accelerates, the US economy will most likely head towards full reopening by the summer. The 2008 financial crisis depressed aggregate demand for a prolonged period. In this crisis, we may see the opposite. US personal saving rates stand at highs not seen since the mid-1970s. Along with large cash piles sitting in corporate balance sheets, they are awaiting a green light signalling the end of lockdowns before embarking on a spending spree. This, at a time when the virus has also damaged the supply side of the economy via disrupted supply chains and business closures.
If we add to this the additional multitrillion-dollar infrastructure package proposed by the Biden administration to address the slack in the labour market, to be possibly financed by hikes in carbon taxes that push up costs, inflation is primed for a resurgence.
At the outset of the crisis, the Fed’s bold action — including large-scale financing of government debt — was timely. Now it is hard not to see it will lead to a de-anchoring of inflation expectations and a revival of the spectre of a 1970s-style growth in prices.
A change in market regime often occurs with a change in the mandate of central banks. The central focus on inflation targeting that started with the arrival of Paul Volcker at the helm of the Fed in 1979 is fading. This much is clear from the new priorities recently adopted by two central banks: achieving full and inclusive employment by the Fed and reducing global warming by the Bank of England.
For investors, this means the rise in bond yields might not be over yet, but its speed may slow down. Take the 2013 taper tantrum in bond markets which followed signals of reduced Fed support. More than two-thirds of the correction happened in the first three months. We believe this might be the case again, with the rest coming after the summer, once economic data reveal the true health of the US economy and its inflation path. The Fed’s role in distorting asset prices is set to diminish as market forces reassert themselves.
As this occurs, expect further gains in so-called value stocks — companies that are considered undervalued compared with their assets or earnings. The first part of a multiyear rotation towards value happened in November in the wake of the positive vaccine news. This resulted in a straightforward re-rating for value stocks from their very depressed levels. Like the recent uptick in inflation, this is not just another blip.
In the long-awaited moment of value stock revenge, investors should pay attention to cyclical names in Europe or companies in the US that can benefit from technological transformation and the energy transition.
The return of inflation could help ease the debt burden. But it will be hard to swallow since it arbitrarily transfers wealth from savers to borrowers. Investors need to prepare themselves for this shift by seeking value stocks rather than chasing new fads.
