You say you want a revolution

Policy pivots will lead to massive shift in investment leadership

“The thing the sixties did,” John Lennon observed near the terminal point of his life, “was to show us a glimpse of the possibilities.” Apart from the two world wars, the Beatles were living through the most explosive and divisive time of the twentieth century. In 1968 alone (the year the Beatles’ tune “Revolution,” written by Lennon, was released), France came perilously close to civil war, Soviet tanks stormed the streets of Prague, and humanity witnessed the assassination of Martin Luther King Jr. The summer of love had mutated into a winter of discontent.

Regime changes may look like a single event in retrospect, but they are never experienced that way. Instead they are protracted periods, decades even, where the existing order disintegrates and is replaced with a new way forward. This is always messy. Old regimes never fall apart neatly and completely – things are taken apart piece by piece. Different people and different institutions with different agendas, however, eventually become fused into a more or less stable constellation. Radicalism ultimately wins.

It is this backdrop – the early stages of an unstable and stealth regime change – where investors stood in the closing days of 2020. The issue at hand is how to create higher and more sustained economic growth. The revolution taking place is in the realm of global policy thinking. How should policymakers respond to a persistently slow growth era and one where coronavirus will cast a long shadow?

The history of global policy thinking: You tell me that it’s evolution

Amidst a global pandemic, moderation suddenly seems inappropriate. This should not be surprising. An urgent desire for change – for fast resolution to turmoil – is characteristic of any crisis. It always takes a trauma to shake up economic thinking. The Great Depression set policy on a far different path, ushering in a Keynesian era where governments used budgets to fine-tune growth and inflation. That orthodoxy came crashing down in the raging inflation of the 1970s. From there, central bankers emerged as the leading macroeconomic managers. By the mid-2000s, they would boast of having achieved a “great moderation”: Economic and inflation variability had been tamed. Everyone agreed that monetary policy was the most effective tool for managing the economy.

All that changed after 2008’s global financial crisis. To fight the downturn, worldwide central banks pursued near unfettered monetary expansion: an additional US$16 trillion amassed on their collective balance sheets. That largesse did not work out as planned as central banks consistently fell short of both their inflation and growth targets. Yet governments flatly refused to engage the fiscal lever in a meaningful way. Deleveraging, austerity, and balanced budgets were in vogue. Monetary policymakers were forced to carry the entire policy burden – grumbling the entire way and becoming the world’s leading fiscal stimulus evangelists.

A new policy approach: You say you got a real solution

All of which brings us to today. The pandemic may not yet be a moment of reform, but it is certainly one of revolutionary break. Fiscal stimulus has arrived fast and furiously. More fiscal spending was announced in the month of April than the entire 2008-2009 global financial crisis. Globally, over US$12 trillion in fiscal support has been pumped into the economy to fight the impact of Covid-19, leading to soaring budget deficits and setting in motion a Super Trend with a durability to last several years.

Have governments done too much? Apparently not. Plans for additional fiscal spending are still widespread, ranging from tax cuts to infrastructure projects to initiatives that move the world further away from its carbon intensity. And a consensus amongst policymakers has emerged: The risks of doing too little greatly exceed the risks of doing too much.

In Canada, the deficit this year is on track to be six times greater than the largest one in the country’s history. Elsewhere, fiscal levers are decisively being engaged. Even the Eurozone – long stuck in an ideological fiscal logjam – has abruptly broken free. The €750 billion European Union recovery fund ratified last July is an historic agreement, smashing through two major taboos: explicit fiscal transfers across member countries and the large-scale issuance of common EU bonds.

Underpinning all of this is a rapidly ascending school of thought called Modern Monetary Theory (MMT). Its central premise is that federal governments are unlike households because they have the power to issue their own currency (read: money printing). Therefore, all the handwringing and ink spilled over governments going broke is misplaced. When governments try to manage their finances like households, they miss out on the opportunity to harness the power of their currency. Above all, MMT is a new way of thinking about the potential for higher fiscal spending. As one of its leading proponents, Stephanie Kelton, has noted: “austerity is a failure of the imagination.” (See my previous posts explaining the implications of MMT and how it’s poised to drive the next market cycle.)

Now whether investors agree with these statements or not is irrelevant. Policymakers are steadily moving toward the adoption of its ideas. And, MMT arrives at a ripe time. An enormous appetite exists for new solutions to the issues facing modern economies. The rolling crises of the last two decades have shaken the public’s trust in established ways of thinking. MMT provides support for a new policy approach.

Looking ahead, the big surprise will be the persistence of government spending. Once turned on, fiscal taps cannot be shut off easily. As Milton Friedman once wryly observed, “nothing is so permanent as a temporary government program.”

Investment implications: Don’t you know that you can count me out (in)?

Just as Lennon’s conflicted lyrics conveyed in the 1968 pop tune “Revolution,” investors can feel powerless during regime changes. And for good reason. The rules of the game are changing. The world we once knew is falling apart. History feels like it is out of our hands.

In reality, however, a fiscal policy revolution has been stirring for some time. Investors should not lose sight of the bigger picture. The last decade was characterized by slow growth, deleveraging, disinflation, and skittish investor sentiment from 2008. Secular stagnation was the dominant narrative. In this environment, investors aggressively bid up assets not linked to broad economic growth: technology disruptors; growth stocks; and fixed income. The U.S. dollar was also chronically strong, perceived as the safest house in a post-crisis neighbourhood. The problem is that all these assets now trade at a large premium, also quickly pricing in their advantage in a Covid-ravaged world.

But what could change this situation? Growth – and a return of some inflation. Investors should not lose sight that fiscal thrusts pack a bigger punch than the monetary variety. Importantly, the transmission effects are much more direct, boosting consumption, investment, and liquidity. More money immediately enters circulation. Inflationary pressures increase.

Many may protest fiscal policies that can lead to currency debasement or simply steal growth from the future. Those are worries for another time. At this point, markets are nowhere close to pricing in higher growth. Cyclicals and value stocks, nearly left for dead by most investors, are starting to show life. U.S. assets will falter relative to other countries as capital becomes braver in its search for alpha. Make no mistake, this is the beginning of a massive shift in investment leadership. The coming spectacle, in the parlance of another era, will be quite a trip.

Tyler Mordy, CFA, is CEO and CIO of Forstrong Global Asset Management Inc., engaged in top-down strategy, investment policy, and securities selection. He specializes in global investment strategy and ETF trends. This article first appeared in Forstrong’s Aug. 31 edition of “Ask Forstrong,” available on Forstrong’s Global Thinking blog. Used with permission. You can reach Tyler by phone at Forstrong Global, toll-free 1-888-419-6715, or by email at tmordy@forstrong.com. Follow Tyler on Twitter at @TylerMordy and @ForstrongGlobal.

Notes and Disclaimers

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