Navigating a Post-Accommodative World
- When the next recession comes, the go-to policy of global central bankers may not be an option.
- Investors should remember that economically sensitive sectors may be impacted in such a scenario.
- Given what we view as increasingly unattractive reward/risk ratios, we believe portfolios could benefit from looking less like the market and benchmarks.
One thing financial markets have grown to count on over the years is the so-called “central bank put,” in which rates are cut and liquidity is provided in the event of a market crisis. But with rates still near record lows and the business cycle lengthening, we’d argue this dependence is becoming worrisome.
As Harvard economics professor Kenneth Rogoff writes in a recent paper: “It is sobering to ask what major central banks will do should another major prolonged global recession come anytime soon. During nine recessions since the mid-1950s, the U.S. Federal Reserve has cut its policy interest rate by an average of 5.5 percentage points. There is hardly room for that now, or into the foreseeable future.”1 In other words, when the next recession comes, the world’s central bankers’ previous go-to policy may not be an option.
U.S. Effective Federal Funds Rate
This is particularly relevant when considering the prospects of the most economically sensitive sectors, such as financials, technology and materials. Although there are valid reasons for the recent strength of these sectors, including improved GDP growth across much of the world and potential tax cuts in the U.S., investors would do well to remember that the economic sensitivity of these companies works both ways.
Approaches to Consider
At Perkins, we are focused on what will happen to earnings, balance sheets and valuation multiples for cyclical companies if central banks cannot jolt the economy out of a downturn. Our analysis generally suggests cyclical areas of the market are rapidly becoming less attractive from a reward/risk perspective, with gaping downside scenarios. Should the market ever reconsider its bullishness, we believe defensive positioning will be well rewarded.
While the pursuit for bargains – generally defined as stocks with limited downside but attractive long-term upside – remains, another potential opportunity lies with what we think of as “the eclectic” stocks. Being less mainstream may mean being less exposed to general bullishness and the potential reversal of that bullishness in the event that central bankers are unable to jump-start the economy. Eclectic stocks also hold the potential to strengthen a portfolio’s diversification. As the market becomes increasingly unattractive from a reward/risk standpoint, portfolios could benefit from looking less like the market and benchmarks.
For more market insights from Perkins, read Gregory Kolb’s recent CIO Outlook.
1Rogoff, Kenneth S. 2017. “Dealing with Monetary Paralysis at the Zero Bound.” Journal of Economic Perspectives, vol. 31, no. 3, 47-66.
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