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One of the key questions that markets are currently trying to answer is whether central banks will be able to engineer a soft landing for the global economy. While an important consideration, I think investors should not overlook the broader structural shifts that are reshaping the investment landscape in this new economic era. Take for instance the dramatic pickup in all types of corporate capital spending we are witnessing in the US. If sustained, this trend could, in my view, trigger a new industrial revolution in the US and beyond, with major implications for fixed income investing.
I think today’s significant increases in capital spending are not a temporary phenomenon but, instead, are being driven by long-term factors such as:
In combination, the size of these additional private nonresidential investment flows (Figure 1) is such that they could materially alter the course of the US economy. Typically, investment in physical assets tend to have much larger positive multiplier effects on economic growth than the asset-light business models that until now have dominated the market.
Figure 1
It is too early to tell whether this new industrial revolution will materialize, given the long history of false starts in US industrial renaissance and the risk that heightened geopolitical turmoil could derail the global economy. Nevertheless, I see several reasons why, for now, data has been surprising on the upside relative to surveys, including:
On balance, therefore, I think the US economy is structurally positioned to deliver higher-than-anticipated growth and that even if a recession were to materialize, it would likely be shallow.
This structural growth momentum coincides with still extraordinarily loose fiscal policy and growing public debt levels across much of the developed world. And while central banks have started an easing cycle to support economic growth, inflation remains in many cases above their target and is likely to pick up again. I therefore believe that the yield curve will eventually steepen and that rates will remain at higher levels than markets currently price in as a combination of stubborn inflation and the need for additional government deficit funding will curtail the ability of the Federal Reserve and other developed central banks to cut rates. The eventual adjustment to this reality of what our macro strategists call “the new economic era” — with higher and more volatile inflation and shorter and more pronounced economic cycles — will inevitably entail more volatility.
How can investors position for the significant risks and opportunities this new environment brings? There is clearly no uniform answer but one potentially attractive avenue, in my opinion, is to adopt a total return approach that enables dynamic pivots across a wide opportunity set.
Specifically, at this unpredictable stage of the cycle, I think such an approach allows investors to:
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