While many forecasters have become bullish as governments around the world look set to begin a fiscal spending regime, a global asset manager has warned investors to remain cautious, amid mispriced assets, astronomical debt and political risk.
Following an extended period of largely ineffectual interest rate slashing, governments appear to be finally returning to fiscal spending to stimulate economic growth but it is not without risk, according to Nikko Asset Management Australia’s head of global multi-assets Al Clark.
“Last year, it was very much about monetary policy, with Japan’s introduction of negative rates, but this year looks entirely different, and the prevailing narrative at the moment is that fiscal policy is going to save the world,” Mr Clark said at Nikko’s 2017 market outlook meeting.
“You can really create incentives with fiscal policy, and drive and enact significant reform, so it’s OK to be optimistic but there are three key risks around this prevailing narrative.”
With the monetary regime finally coming to an end, investors are finding themselves on the cusp of a new era of government spending that has yet to be priced into the market, Mr Clark said.
“The first risk is that assets are priced to the other narrative. We spent years getting asset prices to the point where we all believed there’s no inflation, only deflation, and that assets are backstopped by the central banks so bond prices have been pushed to levels I never thought I’d see in my lifetime.”
With newfound global potential for an inflationary environment, assets will have to be repriced in due course, Mr Clark said.
Equally, the wave of political uncertainty and volatility will threaten the implementation of government spending.
After a year characterised by Brexit, the election of Donald Trump to the White House and the rising tide of populism, the political landscape is perhaps more uncertain than ever.
“If you think about Europe, there’s plenty of risk as well as they go through some significant changes this year. The German government looks like they might be able to retain government this year, but the French government will obviously change power, and if Marine Le Pen wins, then the euro might not even exist,” Mr Clark said.
“There will be a number of different hurdles ahead before these reforms get enacted and there will be a lot of bumps along the way.”
Mr Clark said the final critical issue a fiscal path will encounter will be the level of debt already accumulated in many developed economies.
“Japan’s debt to GDP ratio is over 225 per cent, the US’ is past 105 per cent and most of Europe is beyond 100 per cent as well.
“The obvious concerns are how they’re going to pay it back and what should happen to interest rates?”
Identifying where to invest will, therefore, become a matter of identifying good governance.
“For us, it’s about focusing on governments who will be able to enact reform that will be productive,” Mr Clark said.
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