Inauguration Day Washington DC

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Markets are “forward-looking mechanisms” that focus on longer term fundamentals, says Todd Mattina, portfolio manager and co-lead of Mackenzie Multi-Asset Strategies Team at Mackenzie Investments. So as the Democrats take control of both U.S. houses of Congress and president-elect Joe Biden enters office, any uncertainty may only cause short-term volatility.

Instead, markets will focus on “how the Democrats’ policy agenda over the next two years will impact market fundamentals,” he said in a Jan. 15 interview.

One key item of the Democrats’ policy agenda is a $1.9-trillion fiscal relief and stimulus package, which Biden announced last week.

“The economic impacts of these measures in 2021 are expected to be quite substantial, both on growth, expected inflation this year and, importantly, on corporate earnings,” said Mattina, who’s also senior vice-president and chief economist at Mackenzie Investments. “So the attention is really shifting to those fundamental variables.”

Mattina warned that excessive fiscal stimulus, coupled with abundant central bank liquidity, could drive up inflation and interest rates.

A second key issue for markets to watch this year is when the U.S. Federal Reserve decides to taper direct-asset purchases of Treasurys and mortgage-backed securities. Mattina called signals that the Fed might taper in the near-term “surprising” since the economy is still in recovery and many borrowers are over-leveraged. Fortunately, Jerome Powell and several other regional personnel have tried “to put at bay this idea that we could see tapering,” Mattina said.

“Any increase in long-term interest rates would really put a very fragile economic recovery at risk, and put pressure on those over-indebted borrowers, particularly some of those corporate borrowers,” he explained.

Following a sharp decline in the U.S. dollar against most major currencies, including the Canadian dollar, Mattina said the U.S. dollar has begun to stabilize as the U.S. interest-rate outlook “appears set to stabilize or even rise on that sharp vaccine- and stimulus-driven economic rebound.”

However, he also warned investors to watch for any signs of a lag in vaccine distribution, which could delay the rebound.

Market insights

Mattina warned that inflation for 2021 could climb. “We’ve seen a proxy for expected inflation in 2021 pushing well north of 2.5%, which would be one of the highest expected inflation rates that we’ve seen in the last decade,” he said. “And that’s really on the back of this substantial fiscal stimulus and monetary easing that we’re seeing in the U.S. and other major economies.”

He noted that markets have already priced in a reflation trade — when money exits growth-sensitive assets in expectation of rising inflation. There has been a rotation from tech and growth-sensitive stocks, like the FAANGs (Facebook, Amazon, Apple, Netflix and Google, now Alphabet Inc.), to more cyclical stocks, like industrials, financials and energy.

“Emerging market stocks are also starting to outperform U.S. stocks after years of relative underperformance,” he said. “And we’ve seen the 10-year benchmark Treasury yield pierce that psychologically important 1% level.”

Reflation expectations have also been “bearish for sovereign bonds, particularly U.S. Treasurys,” Mattina said, “which have been pushing toward about 1.1%, breaking out of a much lower sub-1% range for most of 2020.”

Overall, Mattina expects stocks to continue outperforming sovereign and long-term bonds, and he’s overweight on emerging market stocks, as well as the euro.

“The lesson for investors is that if you’re making tactical tilts in your portfolio, in your asset mix, we strongly recommend that those tilts are conservatively sized,” Mattina said. “Keep them small, particularly in this current climate of elevated volatility in markets, where small tilts can have a bigger impact than they do in more normal times.”

This article is part of the Soundbites program, sponsored by Canada Life. The article was written without sponsor input.