Mr. Amato, how sustainable is the influence of rising bond yields on equity markets going to be?

The uptick in US Treasury yields over the last couple of months has been quite substantial; and for the right reasons. Markets predict enhanced economic growth as inflation expectations have also risen. While the environment of low bond yields has been very supportive of long-duration assets globally and equities in particular, it wouldn’t be a good sign for the health of the US economy if long-term interest rates stayed at extremely low levels continuously.

Do you expect the Biden administration’s new fiscal package to be an effective accelerant of the economic recovery?

The package includes a significant amount of income replacement for individuals who have suffered financially during the pandemic. As these measures will add to the already large amount of pent-up demand, they should support economic activity and growth while the vaccine distribution progresses further. However, the second half of the fiscal package could prove to be more than is necessary to stimulate the recovery.

Which consequences would an over-stimulus have?

There is certainly risk of an accelerating inflation. Excess savings are already high; another significant spike in consumer spending power and a simultaneous compressed supply could drive price levels. In addition to that, inflation faces an easy comparison since levels were extremely low in the spring of last year. However, we still believe there are several disinflationary factors in play.

Such as?

Technology and globalization have probably been the two biggest factors limiting inflation over the past decade. Demographics are also a factor, as the working age population in the US is still large. Therefore, while inflation will grind higher, it’s unlikely to consistently reach the range of 3 to 4 percent where it would be problematic.

How will the Fed react to an accelerating inflation?

The Open Market Committee’s decision to target an average inflation of 2% instead of being preemptive was an important signal for markets. Nevertheless, Chairman Powell probably has one of the toughest jobs in the world right now. Navigating the transition from an accommodative to a tighter monetary policy while simultaneously being conscious of inflation and the labor market is a very delicate balancing act. This was evident in the original taper tantrum in the summer of 2013. And it was visible recently, as Treasury yields spiked to over 160 basis points following comments from Powell – although he didn’t signal any policy shift. Expectations in central banks are high across the board and investors were easily underwhelmed when Powell didn’t announce that the Fed was consciously going to work towards keeping rates low at the long end of the yield curve.

When do you expect the Fed to pull back from its easing measures?

I believe the Fed will remain accommodative in 2021 and likely in 2022. The further the coming year progresses the more prominent the policy shift will be on investors’ minds. Right now, policy makers remain focused on getting unemployment down and income levels up, since income inequality is a very hot topic not only in the US, but also across the globe. To achieve the goals regarding the labor market, a coordinated international central bank policy is necessary – the same applies to a successful transition towards monetary tightening.

In this context, how significant are the People’s Bank of China’s recent moves towards a more contractive policy?

Right now, China’s fiscal and monetary policies are very different from those of the rest of the developed world. Beijing has learned from its policies in 2014 and 2015, when the economy got overheated due to aggressive stimulus and margin trading contributed to a bubble bursting in the equity market. As a result, China has taken a more moderate monetary and fiscal approach during the pandemic; now, policy makers surely feel vindicated due to the quick economic recovery. Other central banks have been much more aggressive and – in contrast to the response during the Global Financial Crisis – have received support from the fiscal side. The increased activism by governments is here to stay. While China’s economy has already seen a significant uptick, the fiscal support should drive real growth in the US of between 5 to 7 percent this year, with the momentum carrying over into 2022 and pushing growth above the trend line.

What does this mean for portfolio positioning?

This is the point in the cycle at which investors would want to own value: When the economy bottoms out and starts to accelerate. Hence, I believe that the rotation away from growth stocks that started in September to continue in the coming months. The news on vaccine development in early November have been an important catalyst for equities that are usually sensitive to economic activity, like financials, industrials, materials and energies. The recent outperformance of the Russell 1000 Value Index against the Russell 1000 growth is a good indicator of this development.

How will this affect the performance of US equities against their European and Asian counterparts?

Technically speaking, the US possess a more stable economy than many European countries as well as Japan and Emerging Markets. The high share of technology companies and secular growth have been strong drivers of that stability. In the current environment, however, European, Japanese and certain Emerging Markets indices could profit from their larger share of cyclical components. In addition, the Dollar grinding lower in the long term should be positive for investments outside the US.

Mathematically, the Euro rises on a weaker Dollar. Wouldn’t this be detrimental to many of the export-oriented economies in Europe and their stock indices?

We don’t expect the Euro to appreciate in a magnitude that would choke off economic recovery in Germany and other parts of the continent. Policy makers will have an eye on exchange rates and intervene before the Euro becomes too strong; and although the increase in money supply will weaken the Dollar, it won’t collapse against other developed countries’ currencies.

Do you expect the trade tensions between the US and China to resurface as one of the key risks for markets once the focus on the pandemic tails off?

The Biden administration will take a more strategic approach when dealing with China, be it regarding the opening of markets, industry subsidization or forced technology transfers. This will mark a change from the old administration, which has often been clumsy and heavy-handed in its use of tariffs – consequently, the unpredictability of the Trump presidency likely won’t return. However, the new administration has not yet discussed reducing existing tariffs as such a move would not go over well in Congress nor with the American public. The US and China have entered a battle over technology supremacy which will be fought out over the expansion of the 5G telecommunications standard, domination in the semiconductor sector or innovations in areas like Artificial Intelligence. It’s possible that the world is moving towards a regime of two technology ecosystems, with large players like Apple, whose Asian business is an important source of income, having to navigate between the two.

With trade tensions still looming, will the trend of Chinese companies taking up a second listing in Hong Kong or the Chinese mainland to continue?

That seems likely. There is a lot of pressure in the US on exchanges to ensure the consistency of listing standards for Chinese companies. Exchanges were somewhat compromising in their standards to attract Chinese companies going back five to seven years. Congress is using that to put pressure on the US-China economic battle. If there is a challenge to their New York listing, Chinese companies are logically going to ensure contingency by listing in Hong Kong and tapping into other pools of capital. In that context, it’s positive that the Chinese market has advanced significantly and become accessible to a larger share of foreign investors. Many asset managers, us included, are indifferent between investing in ADRs and buying China A-Shares of a company that offers attractive long-term opportunities.

Chinese markets have been less affected by the recent retail investors’ frenzy than US equities have. How will the recent activism shape markets going forward?

The recent retail frenzy is not that different from what we’ve seen around the millennium. While investors should certainly focus on long-term fundamentals and it’s worrisome to see stocks like GameStop to trade at levels far above their fair value, these cases won’t affect the support and stability of markets. Meanwhile, the democratization of markets through trading apps like Robinhood is certainly positive because it increases investor participation.