A year that was marked by the United Kingdom’s vote to leave the European Union and the United States’ surprise election of Donald J. Trump as president is ending with policy and geopolitical uncertainty emanating from both sides of the Atlantic that could impact economies, markets and portfolios globally. How can institutional investors address unconventional monetary and fiscal policies worldwide?
The key trends:
- Yields on government debt in the U.S. have increased since the election, reflecting market expectations of higher inflation in anticipation of a fiscal boost that could increase government borrowing.
- Investors are confronting uncertainty about the nature of complementary fiscal interventions, a rise in systemic and geopolitical risk stemming from fragile banks in Europe, an increase in protectionist sentiment, the prospect of increased borrowing in the U.S. and Europe, and questions about the health of China’s corporate-debt and property markets.
In this context, the design of forward-looking scenarios may reflect the tension between growth and deleveraging, the effectiveness of unconventional monetary and fiscal measures, and the uncertainty created by geopolitics, including the surge of populist sentiment in the U.S. and Europe. In our Scenarios, Stress Tests and Strategies for the Fourth Quarter, MSCI has modeled three scenarios to help institutional investors evaluate possible impacts on multi-asset class portfolios.
Two of those scenarios reflect possible new market regimes. In those, fixed income portfolios would suffer losses: -6% in the case of inflation surging and -1.2% for a growth revival scenario. In contrast, equity returns vary considerably, with sharp losses of -5.7% in the case of stagflation and gains of +4.8% where unconventional policies revive growth.
In a scenario in which deficits lead to higher inflation, we estimate that multi-asset class portfolios could lose as much as 5.8% of their value. By contrast, our estimate suggests that such portfolios could gain as much as 2.7% if unconventional monetary and fiscal policies spur economic growth.