Global Weekly Commentary: The new nominal, accelerated
A new slim majority
The Democrats gained a slim majority in the Senate, paving the way for greater public spending and reinforcing our macro outlook.
Virus dynamics and macro outlook
A more infectious virus strain could delay the activity restart but we see the cumulative economic loss as a fraction of that seen after the 2008 crisis
Vaccine rollout still in focus
The pace of vaccine rollout amid a virus resurgence will stay in focus in a week of few data releases. Markets have so far shrugged off rioting on Capitol Hill.
The Democrats’ newly gained majority in U.S. Congress paves the way for greater public spending but the narrow margin limits the scope for higher taxes, in our view. We expect this outcome to speed up “the new nominal”, or our expectations for stronger growth coupled with stable nominal yields, even as a more infectious virus strain threatens to make the path to a full activity restart more bumpy.
Chart of the week
Performance of U.S. mega-cap and small-cap stocks, 2020-2021
Past performance is no guarantee of future results. Indexes are unmanaged and do not account for fees. It is not possible to invest directly in an index. Sources: BlackRock Investment Institute, with data from Refinitiv, January 2021. Notes: U.S. mega-cap stocks are represented by the S&P 100 Index, and small-cap stocks by the S&P 600 Index. Performance is rebased to 100 on Nov. 6, 2020, the last trading day before major news organizations declared Democratic candidate Joe Biden had won the presidential election, as well as Pfizer and BioNTech announced the preliminary Covid vaccine efficacy data.
The new virus strain has sent hospitalizations spiking in the UK where it was first detected, and is spreading globally, posing serious challenges to efforts to beat back the virus. It could delay the activity restart in the near term and increase the time needed for the economy to return to its pre-virus trend. Yet ultimately we still expect the cumulative economic activity loss from the Covid shock – what matters for markets – to be just a fraction of that seen after the global financial crisis, and believe investors should look through any market volatility triggered by evolving virus dynamics. The rollout of vaccines is off to a slow start, yet we believe once vaccination becomes widespread it will allow a more forceful restart due to the pent-up demand. As part of our overall pro-risk stance, we are overweight U.S. small- and mid-cap stocks as we see them benefitting from the vaccine-led restart. The prospects for more fiscal spending under a united Democratic government could further fuel the ascent of small caps, after they have significantly outperformed mega caps since the U.S. election, as the chart shows.
We expect significant fiscal support relative to a scenario of ongoing Republican control of the Senate. This could accelerate our new nominal theme, pushing inflation higher over time but with the Federal Reserve keeping the rise in U.S. Treasury yields in check. It also reinforces our turbocharged transformations theme, including the tectonic shift toward sustainability. A Democratic majority could pave the way for major green investment. Last week’s market reaction was consistent with this view. Treasury yields breached 1% for the first time since last March, driven by increases in both inflation expectations and real yields. This suggests markets are likely to test the Fed’s resolve to lean against any excessive climb in nominal yields. We expect greater fiscal spending to be largely funded through increased deficits rather than higher taxes, given the Democrats’ slim majority in both chambers of Congress. The policy revolution has brought on greater tolerance for higher debt globally, yet just how long such attitudes could last is key. Modest increases in corporate taxes may be possible, but large-scale changes including raising taxes on high-income earners, appear unlikely, in our view. Democratic control of the Senate will likely lead to smooth confirmation of nominees to head the regulatory agencies that are crucial for policymaking.
The first half of 2021 is likely to be a choppy ride. The pandemic poses serious challenges to public health and the activity restart, while we see more policy support in the U.S. on top of the recent $900 billion fiscal package. We advocate a barbell approach to risk exposures, with selected cyclicals such as U.S. small-caps and emerging market equities on one end and quality assets including U.S. and Asia ex-Japan equities on the other. We also like tech and healthcare. These sectors benefit from structural trends turbocharged by the pandemic and their strong balance sheets and cash flows provide some resilience against volatility. Yet we recognize U.S. tech could face challenges from greater regulation and corporate taxes.
Bottom line: The new slim Democratic majority in Congress boosts our expectations for more public spending without commensurate tax increases. We also expect a strong vaccine-led restart later in the year. All this reinforces our view on growth, rates and inflation, and underpins our preference for inflation-protected securities over nominal U.S. Treasuries. We expect the Fed to lean against any further spike in nominal bond yields. We remain pro-risk overall, favoring overweights in both equities and credit, but see a potentially bumpy path for asset prices broadly, especially as markets have moved a lot since we published our 2021 global outlook in early December.
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