Asset Classes Views: Climbing the hill

As the new decade dawns upon us, we are beginning to see the light at the end of the tunnel. The unprecedented nature of the current crisis required correctives on multiple fronts on a global scale. With many of these measures in place or in the pipeline, the much-awaited recovery is within reach, but the path forward remains arduous, nonetheless. While we can afford to breathe a sigh of relief having avoided the cliff edge, we remain wary of the tasks that lie ahead in the spirit of the much-celebrated Amanda Gordon’s “The Hill We Climb” to “have our eyes on the future”.

In Amundi’s 2021 Medium- and Long-Term Forecasts, we present a summary representation of possible evolutions of the macro-economic landscape and their impact on the multi-asset investment universe, complemented by the outlook for alternative assets. In line with previous editions, we continue to provide coverage for a multitude of narratives that are singularly relevant considering the current crisis and its ongoing aftershocks. Notably, our focus spectrum now includes ESG (Environmental, Social and Governance), a factor that we believe will play a significant role in moulding future investment opportunity sets.

There is no doubt the climb out ahead of us will be more onerous and atypical of past recoveries. Our central tenet is that policies worldwide will continue to be accommodative for as long as necessary but will be asynchronous because the Covid cycle is at different stages in different regions. The recovery ahead will undoubtedly be uneven, as economic, political, and vaccination setbacks could prove to be potential headwinds to the structural shifts to come. Global economic rehabilitation is bound to be slow yet steady, as authorities maintain a watchful eye on the unfolding events.

The downside scenario we articulated last year has been exacerbated by the Covid crisis from various sources that include inequality, climate change, and divergence of markets and the real economy. The various stimulus packages are only providing a short-term fix to the economy while the supply chain fail to rebuild and monetary authorities run out of manoeuvring room, resulting in inflationary pressures with lagging demand. While this may be a black swan event, experience has taught us the perils of ignoring the rare events.

Amid the gloom lies the distinct possibility that the multitude of ongoing vaccination programmes prove to be successful. In the spirit of Schumpeter’s creative destruction, we have pondered the likelihood of a return to the “roaring 20s”, where from the embers caused by the crisis arises a reengineered economy, with novel industries sprouting productivity gains paired with revamped demand allowing orderly deleveraging. However, we are keeping in mind that this broad range of narratives prepares us for any turning points in the paths ahead to come befitting our role as the architects of Fate.

There is no doubt the climb out ahead of us will be more onerous and atypical of past recoveries

Climbing the hill: medium- to long-term scenarios and return forecasts

2020 was the year when the unthinkable became possible: the global economies experienced a major shock due to the coronavirus pandemic that triggered a loss of productivity, lower capital investment and diminished labour force participation. In the end, policy responses have been powerful and coordinated. The challenge for policy makers now is to heal wounds, provide relief and boost fundamentals to reverse the trends in the major factors that determine growth.

What happened in 2020 anticipated and actually exacerbated, albeit not for the reason we expected, what we set out last year in our downside scenario: EPS (and GDP) recession, rates moving even lower, cemented partnership between monetary and fiscal policies driving the way, resulting in higher debt and inflation.

Policy decisions in the next two to three years will be pivotal

At first glance, in terms of the Medium- to Long-Term Scenario and Return Forecasts, it might seem out of scope, but we think that a focus on the trends for the next two to three years is relevant to outline what comes next.

We are convinced that later in 2021 we will likely get into a juncture for a regime shift: by that time, the pandemic should be under control and fiscal policies will move into the second phase of their impulse, from relief to boost. The economic policy orientation over the next two to three years will influence growth quality, composition and eventually strength, its sustainability and inclusivity and ultimately the inflationary regime.

Macro factors will continue to influence markets

Our medium- to long-term exercise is grounded in the following convictions:

• Macro factors will continue to influence market trends in a more unusual and complex manner¹. Therefore, our macro-founded approach where monetary and real factors are combined in a modular and time dependent framework remains not only robust and consistent, but it is appropriate to encapsulate (exogenous) regime shifts.
• As Pascal Blanqué mentioned in his recent publication²: “the traditional approach based on (real) fundamentals (inflation, growth, earnings), including monetary factors (as a dominant feature of the current transition phase) has to be enriched with “narratives” as a building pillar of long-term expectations. […] Narratives are adding to (or subtracting from) a trend, re-enforcing it or pushing it into a different direction […]”. In our model driven approach to medium- to long-term forecasts, we stylise “narratives” articulating central and alternative scenarios to eventually derive asset class returns.
• We acknowledge that inflation has ceased to be negative: a “bit more” inflation with no pre-emptive central banks is supportive to risky assets and will eventually allow debt to be more serviceable. In 2020, the Federal Reserve and the ECB (still in progress) reviewed their target frameworks as they are aware of the deep interconnection between monetary and fiscal policy.
• Macro determinants and asset classes have much different starting points compared to last year. Despite the faster than expected progress in the development and distribution of vaccines, some economies remain in the grip of the pandemic. Moreover, the structure of some economies (namely the US) has proved more resilient than others (i.e. Europe), while some regions have been more efficient in managing the pandemic (i.e. North Asia). This implies a multispeed heterogeneous recovery featuring country dynamics in the up/downside scenarios where, for example, we expect the Eurozone and Japan to experience smoother cycles.
• The pandemic made ESG investments more urgent. Therefore, ESG will be a relevant component of asset class returns. Besides its clear economic, social and environmental relevance, we believe that ESG can add consistent value and estimate the ESG Equity Risk Premium at around 2% in the long term on top of traditional factors.
• Our investment conclusions for the next three to five years see lower returns on both equity and bonds. We expect equity to outperform bonds with governments yielding negative returns in most cases. Globally, inflation will move higher, within central banks’ targets³. Therefore, it is suitable to diversify into inflation resilient asset classes. We believe that global equities will initially prove good hedges in case of an inflation regime shift triggered by improving economic growth and corporate fundamentals (revenues, earnings).
• To conclude, when compared to last year’s investment strategies, our initial allocation looks less defensive with a tilt to global equities. Moving toward the long term, amid a scenario of returns converging to lower levels, investors should look at real and alternative asset classes. Looking at the strategic asset allocation, at the end of the document we propose two portfolios corresponding to moderate and high risk profiles, constrained to 25% maximum exposure to real and alternative asset classes. Their inclusion in the investment universe helps to enhance the risk adjusted return profile and diversify mainly with respect to fixed income assets.
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Real and alternative assets will enhance risk-return profile of SAA

The document is structured as follows:

1. The first section describes our main highlights and convictions, including a description of our central and alternative scenarios.

2. The second section reports our key asset class views over the medium- to longterm horizon, including some historical comparisons and our macro-economic assumptions for both developed and emerging economies.

3. The third section addresses expected returns by asset class. Shaded paragraphs specifically indicate long term analysis. The section on standard assets ends with the asset allocation implications from a euro investor perspective.

This section includes two themes on low rates and equity sectors:

• We investigate the unintended ultimate consequences of prolonged QE and ultralow/ negative interest rates on financial stability at a time that market structures are changing.
• The reaction to the pandemic differed from country to country: the recovery is uneven and heterogeneous, and dictated by on-off periods (outbreaks and targeted lockdowns). The market is highly fragmented and asset allocation opportunities are opening up at regional and sector levels. The residual scars will likely imply structural changes in the market composition with some sectors struggling to recover (if ever) and others being relaunched. We propose our medium term “winners & losers” list according to central and upside scenarios.

The section ends with the introduction of our strategic asset allocation framework and modelling on real and alternative assets, as well as a presentation of moderate and high risk allocations defined on a global cross asset universe including real and alternative assets.

4. To conclude this year’s edition, we focus on the long-term value of ESG. More specifically we estimate an “ESG risk premium” for equity returns. In addition, we show that firms with the best environmental ratings tend to outperform others. The changes in investors’ preferences for green assets amplify price movements while neither an equilibrium nor a tipping point is visible yet.

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<sub>1. Rethinking the macro and cross-asset research: what we have learned from the Covid-19 crisis, The Day after #10 series, M. Defend, July 2020.
2. Do not give up on fundamental valuations, CIO Insights, P. Blanqué, March 2021 : Do-not-give-up-on-fundamental-valuations
3. Only select EMs might experience high inflation, meaning persistently above the targets.</sub>