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GMP View Points: January 2021 Thumbnail

GMP View Points: January 2021

Remember College? All of the finance classes where you learned about inflation? 

Oh, wait, you didn't take classes where you learned about inflation and how it impacts your saving and investing strategy? 

You are in luck. I am about to teach you a very timely lesson. 

Stay with me. I believe you owe it to yourself to take a few minutes to read this newsletter. 

Inflation impacts how much you pay for a loan, how your investment portfolio performs, and how much you pay for everyday goods. 

As inflation is expected to increase, I believe it is essential to understand how it impacts you as a saver and an investor. 

I will start by taking some time to discuss the difference between nominal yield and real yield and why it matters. 

Nominal yield is the interest rate someone is willing to pay you to lend them money. A good example is the interest rate a bank is willing to pay you on a money market account or a CD. 

Real yield is the actual return you get after taking the nominal yield and subtracting inflation. 

An example might help with this topic. 

  • Let’s say you deposited your money into a money market account, paying 1%.
  • Inflation numbers were 3% for the same year.
What does that mean? Your real yield was -2%. In other words, you safely lost money as the cost of living, also known as inflation, grew faster than your money grew. 

As you can see from this example, inflation negatively impacted the example investor. 

But how is this good for the stock market?

Investors looking to grow their money to pay for expenses should not count on safe investments like bonds and cash as real yields may be negative. As such, investors will continue to drive up demand in stocks as a way to accomplish their goals, ultimately supporting growth in stocks. 

I have long flagged the potential for higher inflation in the medium term, and markets have awoken to this prospect amid expectations for a large U.S. fiscal stimulus. I don’t see this derailing the stock market rally in the near term. I expect a muted response of nominal yields to inflation. This keeps me pro-risk, even as the road ahead could be bumpy due to COVID-19 dynamics.

👉Key Takeaways 

1. The New Nominal
  • I see stronger growth and lower real yields ahead as the COVID-19 vaccine-led restart accelerates and central banks limit the rise of nominal yields – even as inflation expectations climb. Inflation will have different implications compared to the past.
  • The policy revolution as a response to the Covid shock implies that nominal yields will be less responsive to rising inflation risk than in the past. This suggests risk assets will perform better than in past inflationary time periods.
  • Medium-term inflation risks look underappreciated. Production costs are set to rise on a rewiring of global supply chains. Central banks appear more willing to let economies run hot with above-target inflation to make up for past inflation undershoots. They may also face greater political constraints that make it harder to lean against inflation.
  • Market implication: Strategically, I underweight nominal government bonds, favor inflation-linked bonds, and see equities supported by falling real rates. Tactically I am pro-risk, preferring U.S. equities and high yield credit.

2. Globalization Rewired

       • The pandemic has accelerated geopolitical transformations such as a bipolar U.S. -China world order, and a rewiring of global supply chains for greater resilience – with less emphasis on efficiency.

  • Strategic U.S.-China rivalry looks like it's here to stay, with competition and bifurcation in the tech sector at its core. I believe investors need exposure to both poles of global growth.
  • Market implication: Strategically I favor deliberate country diversification.

3. Historic Returns

  • 2019 S&P 500 returned 31.5% and bonds returned 8.7%
  • 2020 S&P 500 returned 18.4% and bonds returned 7.5%
  • Since 1926, we've only seen four other periods with back-to-back calendar years of returns with stocks above 16% and bond returns above 7%.
  • Market implication: Investors need to be very aware of the risk their portfolio is taking. Additionally,  they need to have full conviction about their investment strategy.
Source: Blackrock January Student of the market report.

👉Investment Portfolio Key Takeaways

  • Maintained my overweight to stocks
I still have confidence in the longer-term sustainability of a cyclical-led rally in stocks but tactically I reduced overall exposure to acknowledge full valuations and short-term uncertainty.

  • Move to neutral across the US and Developed Market equities.
I unwound my long-held US overweight and Developed Markets underweight positions based on the recent relative strength of Developed Market corporate earnings estimate revisions and earnings surprises.

  • A mixture of value and growth
I continue to find the strategy of a barbell exposure to value and growth an attractive risk/reward opportunity and further extend this theme by adding
to momentum stocks and introducing more direct exposure to Developed Markets value stocks.

👉Key Index Returns

Dow Jones Industrial Average       

MTD % 3.3 

YTD % 7.3

NASDAQ Composite                        

MTD% 5.7

YTD% 43.6

S&P 500 Index                                  

MTD% 3.7

YTD% 16.3

Russell 2000 Index                          

MTD% 8.5

YTD% 18.4

MSCI World ex-USA*                        

MTD% 4.5

YTD% 5.2

MSCI Emerging Markets*                

MTD% 7.2

YTD% 15.8

Bloomberg Barclays U.S.               
Aggregate Bond TR

MTD: 0.1

YTD: 7.5
Source: Wall Street Journal, MSCI.com, MarketWatch, Morningstar
MTD returns: Nov 30, 2020-Dec 31, 2020
YTD returns: Dec 31, 2019- Dec 31, 2020
*in US dollars

👉Final Thoughts

I hope you’ve found this review to be educational and helpful. 

I look forward to helping you achieve your financial goals during these uncertain times.

Thank you for being on this incredible journey with me. I’m so honored by your trust.

Let me once again emphasize that it is my job to assist you. If you have any questions or would like to discuss any matters, please feel free to give me a call.

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