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This quarter, I stress test four consensus views:
- Interest rates will rise only gradually
- High equity valuations are made possible by low rates
- The US equity market will keep leading the world
- Globalization is slowing and China will pay the price
To begin 2021, I’ll focus this edition of Top of Mind on several big consensus views and assumptions about the economy and the markets, including where they could be wrong, what that could mean from an investment standpoint, and how asset owners might want to play the possibilities in their portfolios.
Why spend time contemplating consensus? Sometimes we benefit from the wisdom of crowds. Large groups of market participants may point us to the most likely outcome and provide a sense of what’s priced into markets. Consensus can also form a base case against which divergent hypotheses can be tested. Of course, consensus can also be wrong, and considering that possibility may help us uncover hidden risks and prepare for surprises, both from a mental standpoint (don’t panic, be ready to act) and an asset allocation standpoint (e.g., ensure that a portfolio is diversified across a wide enough range of outcomes relative to consensus). In addition, for those who have strong conviction in a particular non-consensus view, there may be a meaningful risk/reward opportunity. When consensus views prove wrong, the market implications can be dramatic.
Weighing the case for four consensus views
1. Consensus: Interest rates will rise only gradually
There appears to be a strong consensus that interest rates will rise only gradually in coming years and remain well below long-term averages. The 10-year futures contract on the 10-year US Treasury (See Figure 1 in PDF available below) implies a yield of roughly 2% a decade from now. While moving from the current level to 2% is not insignificant, it would represent only a modest retracement over the course of a decade.
How could the consensus be wrong?
One possibility is that rates could be even lower for even longer. While this is far from my base case, I flag it because over the past three or four decades of fixed income market history, the futures market, and consensus in general, has often assumed (incorrectly) that rates are about to “normalize”/increase. They will eventually, but we should recognize that the “consensus” here has been…
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