Giordano Lombardo, Group Chief Investment Officer at Pioneer Investments, opens this month’s CIO Letter quoting Marcus Aurelius: “Look beneath the surface; let not the several quality of a thing nor its worth escape thee”. The subject of this letter is risk. An extract of the main risks that may break the support for risky assets, according to Lombardo, follow. You may access the complete document through the attached pdf file or through this link.
Walking on a Tightrope (Amid the Credibility of Central Banks and the Risk of Crisis)
The first month of the year has confirmed the main scenario presented in our latest Outlook: developed countries’ economies are gathering momentum and Central Banks retain accommodative monetary policies, extending support for risky assets. However, there is no shortage of reasons for being careful going forward.
Emerging Markets stand out as the weakest spot, as most investors refrain from entering countries with high current- account deficits (Argentina, Turkey and other Asian countries are again under the spotlight) or with political uncertainties putting the skids on overdue economic reforms.
None of the sources of volatility spotted recently has dramatically changed our constructive view on risky assets, especially equities. However, in this letter, I believe it is worth focusing on the main risks that may undermine our investment strategy, notably a change in investors’ expectations on monetary policies and the deflation, particularly in Europe:
- – The main risks to an investment strategy favoring risky assets are a change in investors’ expectations on monetary policies and deflation in Europe. Playing with market expectations is not an easy task. In our view, the FED is walking on a tightrope and the risk of disappointing the markets is not negligible.
- – The second main risk to our base scenario is deflation. Deflation is hardly a healthy condition for the economy: it tends to defer consumption and investments, to aggravate the debt burden and dampens economic growth as a result. Being in a low inflation/disinflation scenario or in outright deflation can make a significant difference for financial markets. Equities tend to anticipate the deflation, thus proving how important is the role of expectations and the credibility of the Central Bank.
The place where the deflation risk appears to be more tangible is Euroland. In the Eurozone, the drop of inflation below 1% hides a high dispersion in individual data.
The ECB needs to decide what is the lesser evil: avoiding deflation in the periphery, while allowing for some inflation in the core, or sticking to an “anti- inflationary” orthodoxy, which is going to kill the hopes of an economic recovery. We believe that the market has not fully realized nor priced the risk that the ECB has no plan to counter deflation and that political disagreement will lead to a prolonged standoff on the course of action.
- Another source of risk to our global scenario is a marked slowdown in the world economy, coming from increasing turmoil in Emerging Markets, as we briefly mentioned. As we have seen, the risk is that they become “victims” of a change in the US monetary policy.
You may access Pioneer Investment’s full CIO Letter through this link or by accessing the pdf attached at the top left corner of this page.