Why investors need to be wary of exuberant spending plans

Saxo Bank, a self-styled “facilitator in financial markets”, operates trading platforms for dealing in equities, funds, commodities, bonds, foreign exchange and derivatives. The bank has its headquarters in Copenhagen, but it has a broad international scope, having entered into dozens of partnerships with financial institutions where Saxo tech is rebranded and made available under the client company’s service offering. Given the nature of its business and its interaction with businesses across the financial spectrum, its pronouncements on forward market trends should command our attention.

The investment specialist’s second-quarter outlook for global markets makes for interesting, if not slightly unsettling, reading. Saxo has put together its forward analysis at a time when the US public purse is undergoing an expansionary phase unparalleled in peacetime.

The writers highlight that the US fiscal blow out, and much else besides, is being triggered by what it identifies as the “generational challenges of climate and inequality”. The latter challenge has taken on an even greater political dimension. So, to ensure social stability, the focus will steadily turn to increasing wages relative to capital. Eventually this will probably lead to increasing wage inflation and reduced equity returns.

Imbalances in the global economy

The stark message to investors is that they are “living in a different world now” relative to anything they have previously experienced. The imbalances in the global economy are likely to worsen because central banks have all but exhausted the monetary tools at their disposal, yet the temptation to meddle in the market economy seems as strong as ever. Indeed, Saxo cites the Austrian-school economist Ludwig von Mises, who once mused that “every government intervention creates unintended consequences, which lead to calls for further government interventions”.

It makes you wonder whether some policymakers even have a market economy in mind when they’ve been putting together their recent spending plans – there is more than a whiff of central planning about all this. The Covid-19 outbreak has provided a suitable pretext to abandon fiscal discipline after the great monetary experiment in the wake of the global financial crisis. Steen Jakobsen, chief economist and chief investment officer at Saxo, puts it simply: “the new mantra is to print and spend as much money as possible while rates and inflation are low”.

There is no shortage of evidence to support that claim. Following on from the $1.9 trillion (£1.4trillion) stimulus package that was enacted this month, the Biden administration has been outlining proposals from the initial phase of its hokily titled “Build Back Better” programme. These measures could generate a total of $3 trillion in new spending commitments and up to an additional $1 trillion in tax credits and other incentives. Even prior to these commitments, FitchRatings had US general government debt at 127 per cent of gross domestic product in 2021.

Perhaps profligacy on this scale no longer matters, if – as some economists would have us believe – we have entered a new world of monetary policy, where regulatory reform can keep financial risks at bay. History suggests this is a fanciful notion, as the splurge by the Biden administration could just as easily signify “the epilogue of this failed model of pretend and extend”. Saxo’s focus remains on the unintended consequences of government intervention, but if we are indeed witnessing a switch away from financial stability toward social stability, what are some of the implications for investors?

Spending pledges, high stimulus and tangible assets

It's not a novel conjecture, but Saxo analysis has it that tangible assets will outperform non-tangible ones – perhaps over an extended period. At this stage, we can't be sure the extent to which the Biden spending pledges relate to physical infrastructure, as opposed to, say, bailing out cash-strapped Democrat state assemblies, but Saxo envisages “rising supply constraints and excess demand from government into basic resources”. The supply/demand dynamic has already narrowed across a range of key industrial inputs, so the bank takes the view that “during this coming reflationary environment, investors should increase their exposure to the commodity sector and high-quality companies with low debt leverage”. We also can’t be sure whether this is another indicator that the long-awaited rotation from growth to value is under way, but events through the early part of 2021 seem to suggest that we could witness further equity revaluations in the most speculative growth segments.

Peter Garnry, head of equity strategy at Saxo, warns that as “vaccinations are rolled out and the US economy reopens, it will be in a situation of very high stimulus and no output gap. This has the potential to unleash real inflation for an extended period.” The same scenario could play out within the economies of the UK and many other nations, although it is difficult to gauge the true extent of pent-up demand at this stage. Some of our readers, those who had never experienced a bear market until March 2020, also may never have had cause to factor in inflationary pressures into their investment decisions. That day may be fast approaching if the Saxo analysis is anything to go by.