A Pessimist's Guide to the Rest of the Year

The base case is bright in spite of recent market jitters, but we’re watching 10 numbers that would signal a darker turn.

There are stock investors and bond investors. I am something of a dreamer and like to imagine the potential for growth and profit everywhere. But when the data is good and markets are racing, I try to listen to my inner bond investor, that sober voice that reminds me of all the reasons my money may not get paid back.

A healthy recovery still looks like the best bet this year as government stimulus, central bank accommodation, and vaccines all point to a powerful resurgence of most activities, in spite of lingering scars. But a prudent investor should keep an eye on 10 measures that will signal something is amiss. 

One (percent). This is the big one. It’s hard to know just how high 10-year U.S. Treasury yields can go, but if they somehow drop back to pre-vaccine levels, the current recovery will be in trouble. As Fed Chair Jerome Powell signaled this week, rising yields reflect improvement even if there’s still a long way to go. A significant decline would naturally help bond portfolios, but it would also signal a worrying rise in new COVID-19 cases or that somehow our monetary and fiscal tools just don’t work even when deployed on a massive and synchronized global effort.

Two (trillion). The U.S. Congress is poised to vote on $1.9 trillion in new fiscal stimulus, although the final number may shrink in an effort to draw Republican votes. Meanwhile, the Biden administration is whispering about a further $3 trillion later in the year in infrastructure and climate mitigation investments. It’s hardly likely that Congress will approve the full $5 trillion this year, but the market may start to sputter if it looks like fiscal support is ending at $2 trillion with 10 million Americans still unemployed. 

Three (parties). As the Republican Party gears up for the next campaign, the titanic struggle between President Trump’s supporters and more traditional party activists has touched off not entirely crazy talk that one group or the other may launch a third political party. Other countries clearly manage with more than two parties, but it could signal chaos for America’s immediate economic governance. 

Five (seconds). If it takes that long to think about shaking hands with a stranger in the street by December, it means the COVID legacy will be with us for a while and the recovery will be slower than we thought.

10 (percent growth). One of the bright spots in the global data has been the recovery in trade, often best measured through the exports from powerhouse South Korea. Eulogies for globalization look premature, as its annual exports rose 11% in January after a gut-wrenching 25% decline last April and continue to race higher in market estimates. Mathematically, the number should continue to rise off last year’s weakness. But start rethinking the case for a global boom when you see any number below 10.

25 (percent tariffs). The sum total of Donald Trump’s trade measures as president brought the average tariffs on Chinese imports from 3.1% to 19.3%, and President Joe Biden looks in no rush to remove any of these. He may try once he has consulted with allies about a more coordinated China policy, but a major risk to recovery lies in the darkening mood in Washington around developments in Hong Kong, Taiwan and Xinjiang. Average tariffs could even rise before they start to fall.

30 (thousand dollars). There is no intrinsic way to value Bitcoin, but its sharp rise early this year looks like a sign of market ebullience more than anything else. It will be a bumpy ride for its owners under any scenario, but a drop below its early January levels might be a warning sign that other frothy asset markets are in trouble. Watch for the dollar to appreciate—and for those 1% treasury yields, too. 

50 (dollars). The recovery is naturally driving oil prices higher, and OPEC will be considering more supply to the market at a meeting later this week. But if prices drop back below $50 a barrel, we may all be reassessing the strength of the global recovery.

60 (percent capacity). As we strain to imagine the post-pandemic “normal,” there’s lots of fresh talk of post-vaccine office patterns. Will we all be fully back in the office by Christmas? 50% capacity? Anything closer to the lower-end will signal a major downward shift in demand for urban real estate, business travel, and retailing, indicating much deeper and lingering pandemic scars. 

100 (basis points). Italian spreads over German bunds are now pricing in a pretty sunny base case of reform, investment, and growth under new Prime Minister Mario Draghi. If this number starts heading much higher, it’s a sign not only that Italy may face troubles, but that we should be bracing for another round of internecine struggles over the future of Europe.

Ironically, the market’s current jitters suggest that it’s the bond investors who believe in the recovery more than those who have started doubting the long-term earnings growth of their stocks. But if more than a few of these numbers start popping up on your screen, it may be time to start thinking more about the risks of getting paid back and seek advice from your favorite friend in bonds.

U.S. 10-YEAR YIELD 

Source: Bloomberg. As of February 26, 2021. 

KOREA EXPORT GROWTH (Y/Y)

Source: Bloomberg. As of February 26, 2021. 

BITCOIN PRICE (USD)

Source: Bloomberg. As of February 26, 2021.

ITALIAN BOND SPREADS OVER GERMAN BUNDS (%)

Source: Bloomberg. As of February 26, 2021.

Christopher Smart, PhD, CFA

• Chief Global Strategist & Head of the Barings Investment Institute

Any forecasts in this material are based upon Barings' opinion of the market at the date of preparation and are subject to change without notice, dependent upon many factors. Any prediction, projection or forecast is not necessarily indicative of the future or likely performance. Investment involves risk. The value of any investments and any income generated may go down as well as up and is not guaranteed by Barings or any other person. PAST PERFORMANCE IS NOT NECESSARILY INDICATIVE OF FUTURE RESULTS.