With the resurgence of global economic activity as the COVID-19 lockdowns ease, institutional investors are looking at accelerating corporate profit growth and accommodative monetary policies as strong tailwinds for overall investment performance. Yet these developments also bring inflationary pressures at a time of high fiscal spending. In addition, debt levels are high and rising, and we may be at the beginning of a new era in foreign policy. Pensions & Investments spoke with Biagio Manieri, Ph.D., CFA, managing director and chief multi-asset class strategist at PFM Asset Management, to sort through the current macroeconomic and market risks that asset owners need to understand in order to better position their investment portfolios and avoid a potentially bumpy ride.
Pensions & Investments: As the world slowly gets back to normal, can investors start to relax with the expectation of smooth sailing from here?
Biagio Manieri: We wish that were the case. Investors face a number of risks. Many are risks that they have not had to think about for a long time, such as inflation. The last time investors needed to seriously fret about inflation was in the mid-1960s and 1970s. Since the early 1990s, investors have not had to materially worry about inflation, nor ponder its impact on portfolio performance.
Taking this a step further, many investors who included inflation-related hedging investments in their portfolios over the past decade did not see much of a financial benefit and, in some cases, paid a price in lower investment performance. Today, however, a number of factors may push inflation higher, including the Federal Reserve’s new inflation-targeting framework, significant fiscal and deficit spending combined with easy monetary policy, and other factors.
P&I: What about the Federal Reserve’s position that any higher inflation will be transitory?
Manieri: Federal Reserve Chairman [Jerome] Powell and others have argued that higher inflation is transitory and that [the Fed has] the tools to deal with it. In effect, the Fed is saying “trust us.” If one considers short-term versus long-term inflation expectations, investors are indeed placing a lot of faith in the Fed. That said, investors would be well served to keep a careful eye on early indicators of inflation and be ready to act should it prove to be more than transitory.
P&I: In addition to possible higher inflation, what are other areas of concern for investors?
Manieri: One topic that has received a great deal of attention is the diminishing prospect for higher future investment returns. Because low interest rates are hampering fixed- income returns and have led to elevated equity valuations, many investors are concluding that future returns are likely to be lower.
In addition, there are demographic trends — aging population, slower population growth. We think that most investors understand that. But investors may not be fully accounting for the impact of rising debt and continuing low productivity.
A number of studies have linked debt levels and future economic growth. One study by the International Monetary Fund found that higher debt levels lead to lower future economic growth. It also showed a nonlinear relationship between debt and future economic growth, meaning that as debt increases, it has a proportionally greater impact on reducing future growth.
It is also important to note that the Congressional Budget Office [in the U.S.] estimates that debt held by the public will reach approximately 200% of gross domestic product by 2050. As a reference, it stood at about 100% of GDP during the World War II era.