As the Covid crisis pushes policymakers to redefine our social contract with a focus on redistribution and reducing wealth concentration, reversing the decline in labour’s share of income will be a key tenet to addressing inequality. Higher returns to labour transmitting the effects of improved economic activity to the personal incomes of households are necessary to tackle the rise in income inequality, structural unemployment, and aggregate demand shortfalls.
Bigger government and bigger fiscal change, aimed at sustainable growth and job creation where money printing is aimed at demand generation, is inherently more inflationary.
Local > Global
The pivot to deglobalisation and reduced reliance on China emerged pre-Covid, but the crisis marked a boiling point for the “my nation first” impulse (just look at vaccine diplomacy) and with it, the shift to local over global. Moving forward, companies and nations will focus on reshoring critical areas and adding resilience and self-sufficiency to supply chains via localisation and enhanced regional ties, as well as bidding to secure supply, restore jobs and manage production tail risks. This is another reason to be long inflation, real assets, cyclicals and small caps.
The US/China trade war signalled this tectonic shift, but the pandemic has now accelerated the move on a global scale, including the shift away from China (e.g., Rare Earths). The race for technological supremacy is also spurred by the pandemic’s acceleration of digital adoption – technological disruption, innovation, splinternet and deglobalisation on fast forward.
The pandemic has turbocharged many pre-existing trends as well as forging new ones. With digitisation and disruption in overdrive, the reshaping of our world order is colliding with a physical world that cannot keep up. From semiconductor chips to copper, demand is on the rise while capacity remains constrained. We have underinvested in the production capacity required to meet accelerated digital adoption, green transformation, and the recovered spending capacity that comes with a seismic fiscal shift.
The constraints of the climate and real supply limitations are adding to “cost-push” inflationary pressures, alongside local>global and labour>capital shifts. Add to that the great fiscal shift taking care of “demand-pull” inflation and compounding supply constraints, and it is a cocktail for higher inflation.
A new investment paradigm
The new social contract is in many ways a poisoned chalice for markets as we know them, heavily in the throes of a monetary addiction: slow-flation, TINA, treasurised mega-caps and long duration. However, the status quo has delivered not just huge income inequalities but a polarised era that erodes political and economic stability. If taking a risk on inflation heals this precarity, it may be a price worth paying.
For investors, the macro paradigm shift toward fiscal primacy requires a more inflation-resilient portfolio.
A strengthening growth outlook and rising inflationary pressures are supportive of commodity-heavy indices, small caps, cyclicals, and real economy stocks, but are difficult for multiple highflyers and speculative bubble stocks to navigate. The capacity to shift market leadership has moved toward real economy stocks, non-US markets and commodities. The higher that yields go, the more pressure is on this rotation.
Expect higher volatility in this transitory environment: the entropy of the system results in suppressed volatility escaping. With inflation on the rise and fiscal dominance in the hot seat there are few elegant ways for central banks to continue to tame volatility.
Find a new hedge: 60:40 no more.
Real assets/Commodities: Real assets > Financial assets. The allocation to commodities and commodity producers must be higher. A hedge against inflation but also positioning for tailwinds of supply constraints and price-inelastic demand, and green transformation.