In its 2021 mid-year investment outlook, published on June 21, Invesco laid out its assessment of the market’s mid-term future. While generally optimistic about capital markets, the asset manager warned of two risks that could threaten to derail the bull market: non-transitory inflation and resurgence of the coronavirus pandemic.
Beware rising rates of inflation and infection
After years of effort to raise inflation from near zero, the Federal Reserve finally succeeded in recent months. However, as I discussed recently, controlling inflation once it starts can also prove to be challenging. Invesco’s decision to flag non-transitory inflation as a key market risk, and to game out such a scenario, is proof of that fact:
“In this scenario, we contemplate rapid growth accompanied by a quickening pace of inflation. Markets would anticipate higher inflation and Fed tightening, causing the yield curve to steepen.”
As I have previously covered, a resurgence of inflation risk should serve as an impetus for prudent investors to reconsider their market positioning and allocations. While investors cannot control inflation, they can control their exposure to it. Should Invesco’s second major market risk, a resurgent pandemic, occur, however, it may be harder for investors to adapt:
“A resurgence of the pandemic remains a key risk to the outlook: A renewed uptick in infections in developed economies where effective vaccination is widespread could prompt reinforced social distancing or partial lockdowns. Where effective vaccination is limited, notably in several economies (e.g., India, Brazil, Asia Pacific), stricter lockdowns may be required. These risks may prevent full reopening.”
While further pandemic-related disruptions would undoubtedly be problematic for the economic recovery, as well as the bull market, Invesco has predicted a more limited impact, should it occur at all. This is due to the long-term behavioral shifts, such as the accelerated transition of both economic and social activity onto the internet, that would make future lockdowns less damaging. Even so, rising concerns about infectious variants should not be ignored.
Optimism still reigns amid uncertainty
Despite its warnings about potential high inflation and pandemic disruptions, Invesco’s mid-year forecast remained fundamentally optimistic:
“In our base case scenario, which we believe is highly probable, we expect global growth will accelerate through early 2022. Inflation is expected to rise during this period but will be temporary and controlled. We expect continued fiscal and monetary policy stimulus, which should help support risk assets.”
Market reports and forecasts can help shed some additional light that yield tangible benefits for investors, but they can also get things wrong. Not knowing what the potential risks are in the first place, for example, has caused issues for more than a few market forecasters over the years.
Having a clear-eyed view of existing and potential financial risks is crucial for any investor, of course, but the future is often rather foggy in practice. However, Invesco has argued that the market’s future may be more certain than in years past:
“In contrast to most past cycles, we see the tail risks as being higher and better defined than is usual in a recovery environment such as the post-global financial crisis environment.”
While the risks of rising inflation and infection are clearly real, I am reticent to endorse Invesco’s optimistic assessment of its own ability to better identify market risks compared to previous cycles. In the weeks since its publication, warning signs concerning each of the risks identified in the mid-year forecast have already proliferated, potentially threatening the asset manager’s bullish base case.
No doubt market forecasts can be useful tools for investors of all stripes. Yet, as I have discussed previously, they can also prove dangerous if followed unthinkingly.
In my assessment, it is important to always take the conclusions of any market outlook or forecast with a healthy dose of skepticism. Still, I see ample reason to pay close attention to both of the risks flagged by Invesco in its mid-year market outlook.
Should inflation spiral out of control, or a resurgent pandemic again disrupt economic activity, the bull market may struggle to keep on chugging.