My team and I often say recessions wipe the slate clean and create new investment patterns that will likely be dissociated from the last cycle. If there was a dominant theme of the last cycle — from the global financial crisis (GFC) in 2008 up to the onset of COVID-19 in March 2020 — it may have been “secular stagnation,” which I define as low nominal economic growth due to shortfalls in aggregate demand. Naturally, this begs the question of whether or not secular stagnation will still have legs in the post-COVID era.
I don’t claim to have a simple “yes” or “no” answer yet, but for now would like to share my latest thinking on the topic, to be followed by deeper dives on specific aspects of it (and hopefully more definitive answers) in additional blog posts throughout 2021.
Whence secular stagnation?
By way of context, it’s helpful to consider how we got here in the first place. Economists have attributed secular stagnation to a number of factors and trends, including demographics, inequality, globalization, oligopolies, and debt deflation. For my part, I believe there have been three main causes:
- The widespread “savings glut” outside the US, dating back to before the GFC, which also became a US phenomenon post-GFC (Figure 1);
- The effects of global monetary policy, which since 1979 has been explicitly focused on bringing inflation down toward central banks’ targets; and
- Declining investment spending in the US, as a percentage of domestic GDP, over the past 30 years or so.
I will explore each of these in greater detail, along with what the future might hold, in upcoming installments of my “secular stagnation” blog series.
So what now? Here are some medium- to longer-term thoughts:
- Notably, I expect global savings rates to fall from currently high levels and also remain below the elevated levels that marked much of the 2010s.
- This could facilitate a consumption-led, higher nominal-growth environment that exacerbates the US’s current-account woes and leads to further USD declines.
- Financing deficits could also become a problem for the first time in decades as global savings rates begin to decline (as noted above), perhaps meaningfully.
- This, combined with revised US Fed policy, could spell an end to secular stagnation if defined narrowly as low nominal growth stemming from insufficient aggregate demand.
- However, while nominal growth and nominal rates could rise, I expect neutral real rates to stay low and am not confident that investment, particularly private-sector investment, will pick up.
- The public sector could step in to fill this investment void, although the nature and composition of further government stimulus will determine its efficacy (or lack thereof).
How should investors position fixed income portfolios in a world where nominal growth is likely to be structurally higher than in the previous cycle, coupled with persistently low neutral rates? A few high-level suggestions:
- Short USD, long inflation-linked bonds, as a consumption-led cycle could lead to worsening current-account conditions, a weak USD, and rising inflation expectations.
- Maintain decent levels of duration, but look to extract that exposure from outside the US, where I believe there are better opportunities than US Treasuries.
- Short investment-grade (IG) cash bonds, as I suspect supply could surprise to the upside and overwhelm lower global savings, causing IG spreads to widen.