The pandemic has marked a turning point for asset markets

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The pandemic has marked a turning point in financial markets. In coming years, asset allocators will need to be much more active when macro shocks occur and will need to work far harder to preserve absolute returns for their clients.

Author: Gavyn Davies, Chairman, Fulcrum Asset Management

January, 2022

Although the Covid-19 pandemic has brought great uncertainty to global business activity since March 2020, the financial markets have reacted with remarkable insouciance. Stimulatory macro-economic policies in all the major economies have prevented deep recessions and lengthy meltdowns in financial markets. With the exception of a couple of months of panic when Covid-19 was first identified, the great bull market in risk assets continued apace.

As the economic concerns from the omicron variant appear to fade, what can investors learn from the past decade, encompassing both the prolonged recovery from the Great Financial Crash and the two years of the pandemic?

A golden decade for risk assets

Taken as a whole, the past decade has been a truly remarkable period, with extremely strong performances from all risk assets, led by large cap growth stocks in the US market, especially in the technology sector.

  • Since 2011, total returns on US equities have averaged 13.7% per annum, with the technology-heavy Nasdaq index rising by a startling 21.4% per annum.
  • Global equity markets have been somewhat less impressive but have still risen at the very healthy annualised rate of 9.3% in dollar terms over the entire decade.

These strong returns from equities and other risk assets have not been fully matched by bond markets.

  • Nevertheless, US treasuries have offered positive returns of 3.0% per annum.
  • As a result, standard 60/40 equity/bond portfolios have performed consistently well, especially in the US.
  • Furthermore, risk parity funds, which raise the bond weight so that bond and equity risk are roughly equal, have done even better, returning 8.7% annualised since 2011.

It has therefore been a golden era for investors who have remained consistently exposed to the two main asset classes. For the most part, these returns have been fully justified by economic “fundamentals”.1

Strong economic fundamentals

Looking back, there have been four main contributing factors.

  • Equity valuations as the post-GFC recovery gathered steam in 2011 were attractive. For example, the Fulcrum asset allocation model, built by Juan Antolin Diaz’s team, was predicting US equity returns of around 9% annualised over the medium term, slightly above average. The Shiller CAPE, a commonly used measure of equity valuation, stood at 20, compared to an average of 27 so far this century. There was plenty of room for equity prices to rise, relative to earnings and dividends.
  • The decade recorded very high growth rates in corporate earnings and distributions to investors. In the US, nominal dividends rose by 9.1% annualised, compared to 4.8% for nominal GDP. The pattern of high returns to shareholders, compared to wage earners, continued.
  • Adverse supply shocks in the global economy were notable by their absence. Geopolitical crises, especially those leading to sudden spikes in oil prices, had been the prime enemy of stability and high returns in asset markets in previous decades, including just ahead of the Great Financial Crash. But in the latest economic cycle, the main shock to oil prices was downwards, when extra supply from American fracking caused the WTI price to plummet by two-thirds in 2014-16. Over the entire ten years, oil prices were broadly stable.
  • Perhaps most important, the long-term downtrend in nominal and real interest rates was maintained during the decade.2

The decline in interest rates and r*

Many investors attribute this powerful trend in rates to the actions of the central banks, and they certainly did their best to depress long term yields by buying unprecedented amounts of government debt in successive doses of quantitative easing.

But the deeper cause of lower rates was the continuing drop in r*, the equilibrium short term real interest rate in the global economy. This rate, which is conceptually that which allows the central bank to hit its inflation target when unemployment is at its sustainable rate, has been falling since the 1980s, and it has dropped by about 2 percentage points since the Great Financial Crash.

Central banks were forced by what Lawrence Summers called “secular stagnation” to cut their policy rates by at least that amount in real terms to leave the policy stance unchanged, and this was eventually reflected in long term bond yields.

The decline in interest rates across the yield curve automatically reduced discount rates on all income earning assets, boosting the fundamental value of assets such as equities and real estate. Those assets with the longest “duration” (i.e., expected returns far out into the future), such as equities in the massive US technology sector, benefited the most.

These macro factors comfortably explain why the past decade has been so rewarding for asset holders. However, they do not explain what has happened in the last two years of this period, i.e., the years of the pandemic.

Super-charged returns during the pandemic

Since the end of 2019, the rise in equity prices has sky-rocketed, while the fundamentals have been unimpressive. The S&P 500 has risen at an annual rate of 21%, while dividends have grown at only 1.8%, and bond yields have dropped only fractionally.

This super-charged surge so late in the bull market, though extremely rewarding to those investors who have remined exposed to it, is hard to explain in rational terms.

It is certainly true that the dramatic action taken by the finance departments and central banks in the advanced economies to soften the economic blows from the pandemic have been extraordinarily successful. Based on the latest forecasts, US real GDP will expand by 7.7% cumulatively from 2019-22, close to its long-term trend rate.

The hit to the economy relative to its potential rate, has therefore been negligible. By comparison, in the three years after the start of the GFC in 2007, the US economy expanded by only 0.4%, thus falling far below its potential.

The success of macro policy during the pandemic represents a powerful lesson to those who doubted that the economic equivalent of shock and awe can work.  “Old Keynesian” fiscal expansion, combined with aggressive intervention by central banks to stabilise asset markets, prevented a deep recession when a severe and unprecedented demand shock occurred. The markets may have come to believe that this transparent success will result in a permanent reduction in recession risk in future.

But this is not enough to justify the extraordinary recent behaviour of risk assets.3

Fundamentals are becoming much less supportive

None of the fundamental factors that drove the bull market before 2019 are likely to be as favourable in coming years.

  • Equity valuations are now in the stratosphere. The Shiller CAPE stands at 39, an all-time high. Furthermore, the Fulcrum asset valuation model (see box below) is now predicting real equity returns of only 2.6% per annum over the next 3 years, which is abnormally low.4
  • With labour markets close to full employment, and policy aiming to raise the minimum wage sharply in many economies, there could be an increase in the wage share in national income, relative to profits and dividends.
  • The long-term decline in r* might be slowed or reversed by expansionary fiscal policy in the US and EU, and by the impact of clean energy investment.
  • Supply shocks from the climate crisis may become disruptive.

Supply shocks from global warming and climate policy

The impact of policies to reduce global carbon emissions, while extremely welcome in the light of the climate emergency, could lead to more volatile energy prices, with unpredictable spikes such as those we have seen in 2021.

It is estimated5 that the rise in carbon prices needed to restrict global warming to 2 degrees or less will represent at least 3-4% of global GDP in coming years. This should be seen as a negative supply shock similar in scale to the OPEC-induced oil price rises in 1973-74, which triggered a period of global stagflation.

Macro policy makers need to start thinking seriously about how to smooth this shock, without “kicking the can” too far into the future. This debate can no longer be left just to the climate scientists; it is now a macro-economic issue front and centre, though is still barely discussed in macro policy circles.

The modest signs of progress made in the Cop 26 talks in Glasgow last November show that international agreements to curb emissions are possible, but implementation of the necessary policy changes remains unimpressive. As the economic story of the 2020s progresses, climate policy will join monetary policy as a prime area of concern for macro traders and asset allocators.

Why supply shocks are bearish

As the climate deteriorates, and mitigation measures become more urgent, sudden supply shocks to the global economy might become much more important, relative to the demand shocks that have been dominant in the advanced economies since the 1980s. If so, this will make life much harder for asset allocators.

When demand falls, the impact of lower equity prices on asset portfolios is offset by rising bond prices (i.e., falling yields). The two main assets automatically tend hedge each other, reducing overall portfolio volatility and encouraging higher average holdings of risk. Over time, this boosts average returns.

The opposite is true when a contractionary supply shock, such as a spike in oil prices, occurs. Equities still decline, but higher inflation this time increases interest rates and reduces bond prices. Both main asset classes turn negative, forcing sharp risk reductions to preserve wealth. In the era of higher carbon prices, these supply shocks may become increasingly common, disrupting portfolio performance.

Implications for Asset Allocation

This article has shown that the last decade has experienced consistently high returns for passive holders of 60/40 or risk parity portfolios, driven largely by macro-economic fundamentals. However, during the fight against Covid-19, the further acceleration in returns has not been fully justified by fundamentals.

Furthermore, the post-pandemic economic cycle is unlikely to share the same favourable characteristics that applied during the recovery from the GFC.

At the end of 2021, the Fulcrum MARS model (see box below) was predicting extremely low real returns from the main US asset classes over the next 3 years: 2.6% per annum for equities, 0.7% for commodities, -0.4% per annum for bonds and -1.3% for cash.6

These return forecasts resulted in asset allocation recommendations from the model (three years forward) which are also very unusual:  equities 21%; commodities 17%; bonds 24% and cash 38%.6

This defensive stance in the recommended portfolio is a large break from the results that have been seen during the golden decade. While Fulcrum investment managers do not adopt these model results automatically in managing client portfolios, they do offer reasons to be cautious in risk positions in coming quarters. 

The pandemic has marked a turning point in financial markets. In coming years, asset allocators will need to be much more active when macro shocks occur and will need to work far harder to preserve absolute returns for their clients.


The Fulcrum MARS Asset Allocation Model

The asset allocation results reported in this article are derived from a new model recently estimated by Fulcrum economists, led by Juan Antolin-Diaz. This model brings together a decade of Fulcrum’s econometric work, including earlier models for forecasting the real economy and inflation (notably using nowcasting techniques), asset market returns and asset allocation. The integrated system is still in an experimental mode, though its results are now actively scrutinised by the team of discretionary investment managers at Fulcrum.

The MARS model is a Bayesian Vector Autoregression system using the following US variables:

  • macro financial variables including inflation (GDP Deflator), real GDP growth, credit spread (defined as the difference between Moody”s BAA bond yields and 10-year bond yield), dividend growth, price/dividend ratio, real cash rate and term spread (defined as the difference between 10-year bond yield and 3-month treasury bills);
  • asset market variables including real commodity prices, commodities’ carry, excess stock returns, excess bond returns and excess commodities returns.

For the current quarter, inflation and output growth data are Fulcrum nowcasts, whereas the other variables use the closing value of the previous day.

The model is estimated with data starting from 1955 and with four lags, using the technology developed by Antolin-Diaz, Petrella and Rubio-Ramirez (2021) Dividend Momentum and Stock Return Predictability: A Bayesian Approach by Juan Antolin-Diaz, Ivan Petrella, Juan Rubio Ramírez :: SSRN.

Importantly, the Campbell-Shiller conditions for equities, bonds and commodities are correctly imposed in the lagged coefficients and the variance-covariance matrix, setting this model apart from the rest of the academic literature.

We intend to report the results from this system periodically in the future.8

Source: This note is based on material which appeared in an article by Gavyn Davies published in the FT Advisor on 20 December 2021.


[1,2,3] FT Adviser – What has been the true economic impact of the pandemic, 20 December 2021

[4] Fulcrum Asset Management LLP

[5] www.piie.com Climate policy is macroeconomic policy, and the implications will be significant, August 2021

[6,7,8]Fulcrum Asset Management LLP


This material is for your information only and is not intended to be used by anyone other than you. It is directed at professional clients and eligible counterparties only and is not intended for retail clients. The information contained herein should not be regarded as an offer to sell or as a solicitation of an offer to buy any financial products, including an interest in a fund, or an official confirmation of any transaction. Any such offer or solicitation will be made to qualified investors only by means of an offering memorandum and related subscription agreement. The material is intended only to facilitate your discussions with Fulcrum Asset Management as to the opportunities available to our clients. The given material is subject to change and, although based upon information which we consider reliable, it is not guaranteed as to accuracy or completeness and it should not be relied upon as such. The material is not intended to be used as a general guide to investing, or as a source of any specific investment recommendations, and makes no implied or express recommendations concerning the manner in which any client’s account should or would be handled, as appropriate investment strategies depend upon client’s investment objectives. Funds managed by Fulcrum Asset Management LLP are in general managed using quantitative models though, where this is the case, Fulcrum Asset Management LLP can and do make discretionary decisions on a frequent basis and reserves the right to do so at any point. Past performance is not a guide to future performance. Future returns are not guaranteed and a loss of principal may occur. Fulcrum Asset Management LLP is authorised and regulated by the Financial Conduct Authority of the United Kingdom (No: 230683) and incorporated as a Limited Liability Partnership in England and Wales (No: OC306401) with its registered office at Marble Arch House, 66 Seymour Street, London, W1H 5BT. Fulcrum Asset Management LP is a wholly owned subsidiary of Fulcrum Asset Management LLP incorporated in the State of Delaware, operating from 350 Park Avenue, 13th Floor New York, NY 10022.
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About the Author

Gavyn Davies

Gavyn Davies is Chairman of Fulcrum Asset Management and co-founder of Active Partners and Anthos Capital. He was the head of the global economics department at Goldman Sachs from 1987-2001 and Chairman of the BBC from 2001-2004. He has also served as an economic policy adviser in No 10 Downing Street, and an external adviser to the British Treasury. He is a visiting fellow at Balliol College, Oxford.

Gavyn Davies
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