Default and insolvency cycle may start post-September: DSP Mutual Fund3 min read . Updated: 22 Jun 2020, 11:33 AM IST
- The current rally in stock markets around the world has been fueled by central banks’ liquidity infusion rather than fundamentals, as moratoriums have reduced the need to use the liquidity to pay interest.
DSP Mutual Fund has laid out a four-stage macroeconomic roadmap for the world economy for the current decade. According to this model by Debashish Bose, vice president, product management at DSP Mutual Fund, we are currently in a liquidity-fueled rally, which is stage 1 of the roadmap.
This may shift to a default and insolvency phase in September when debt moratoriums world-over will come to an end. This phase could be characterized by defaults and deleveraging (debt reduction) and may not be positive for equities. This is expected to be followed by a fiscal-led push for growth and then stagflation or hyperinflation.
So what is this macro roadmap and what does it mean for your investments? We explain.
Stage 1: Liquidity-fueled rally (till September)
According to Bose, the current rally in stock markets around the world has been fueled by central banks’ liquidity infusion rather than fundamentals as moratoriums worldwide have reduced the need to use the liquidity to pay interest. He expects this to last till August-September at which point numerous debt moratorium programs will end and a more realistic economic scenario may emerge.
Positive for US equities and gold.
Stage 2: Debt deflation (2020-2022)
As the moratorium schemes come to an end world over, it will become more apparent, which industries face either existential threats or significant disruptions to their current business model. A default and insolvency cycle could cause deleveraging or government and central banks-led bailouts, which has a deflationary effect. In such an environment, cash and equivalents, especially in dollars, will be preferred over all other asset classes
Positive for US dollar and US government bonds.
Stage 3: Fiscal expansion-driven growth (2022-2025)
As a response to a deflationary cycle, which will likely also be characterized by rising unemployment, governments will need to respond with enhanced fiscal spending to spur GDP growth and job creation in major economies. This can create a reflationary cycle, which likely starts with essential items like food and then spreads to other products. The need to rebuild industries for employment generation can also create a demand for industrial commodities. Continued stimuli would also likely lead to fears on currency devaluation which is beneficial for gold.
Positive for emerging market equities, gold and agri-commodities.
Stage 4: Hyperinflation or stagflation (2025-2030)
Exiting aggressive fiscal and monetary policy measures as an economy is recovering is an extremely difficult task and can potentially lead to inflation as rising demand comes up against supply constraints. Continued government spending to push lackluster growth could potentially cause hyperinflation
or stagflation towards the latter half of the decade. Currencies could see sharp swings which further adds to this.
Positive for precious metals, industrial commodities and infra or commodity stocks.
Financial planners are divided on how likely these scenarios are and how investors should respond.
"The current rally in global markets is far from ground reality. It appears that the rally is driven by liquidity and quick recovery hopes. However, it looks like markets will stay in a good mood up until the US election scheduled in November 2020. Investors will have to be careful with their equity allocation," said Bhavesh D Damania, founder and chief care taker, Wealthcare Investments.
However, Amol Joshi, founder, Plan Rupee Investment Services dismissed such predictions. "At best investors should make small tweaks in their portfolio if the roadmap looks plausible to them. I don't think it is feasible to switch in and out of investments according to what is predicted here. There are a lot of unknowns that result in many different scenarios," he said.
Investors should align their investments with their financial goals. Cyclical changes in the world economy cannot be predicted and adjusting portfolios for them can cause you to miss out on major gains in your equity or debt funds.