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This quarter, we outline a proposed new playbook for navigating an economic recovery unlike any other. Although some aspects, notably improving growth, will be similar to past recoveries, this time around there are important differences — starting asset valuation levels, the surrounding policy backdrop, the trajectory of the recovery, and the future state toward which we are recovering. Investors should keep these differences firmly in mind as 2021 unfolds.
A different type of economic recovery
Most economic recoveries begin after a cyclical downturn in aggregate demand (business and consumer) and are led by a revival of this demand. That type of recovery has a clear playbook for most investors to follow, such as being “long” cyclicals, “short” interest rates, and overweight regions more geared to economic growth. This time around, however, we are not recovering from a demand-led cyclical downturn, but rather from government-mandated lockdowns of world economies. As such, while some aspects of the recovery will be similar to past episodes, others will not be, as shown in Figure 1.
Starting with what is similar, as in all economic recoveries, we expect growth to pick up in 2021 and, indeed, likely run above average (relative to its long-term trend) as pent-up demand is released, inventory levels are rebuilt, and consumption increases going forward.
However, one obvious difference lies in where asset valuations sit at the start of this particular recovery period. Many risk assets will begin this economic recovery at valuation levels well above historical norms and with broad markets at record highs, both of which are usually features of the top of a cycle, not the bottom. US large-cap equities are a good example of this, but it applies across most risk assets these days, with the possible exceptions of emerging markets and value-oriented styles. We believe this difference in starting valuations implies the need for more focused allocations to areas that have greater valuation runways, as broad market returns are likely to be lower during this recovery period as compared to previous ones.
Secondly, this recovery will likely differ in how it progresses. Normally, an economic cycle progresses through the various geographic regions and asset classes according to their cyclicality, led by the most cyclical regions and assets. However, this time the recovery will also…
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