The economists and analysts who see share prices declining in 2021 are few and far between. The same optimism prevails with regard to economic growth in 2021 and 2022. Furthermore, there is a fairly firm conviction that inflation – and therefore interest rates – will remain very low almost everywhere for the time being.

Finally, many experts see the dollar weakening in 2021. First of all, against the Asian currencies, but generally also against the currencies of the industrialised countries. Experience shows that something else usually happens in the event of major consensus expectations.

Positivism with regard to shares is mainly determined by two factors. First of all, by the expectation that the economy will pick up considerably once large-scale vaccinations take place, and secondly by the prospect that the central banks will open the money tap even wider as soon as something goes pear-shaped. This gives buyers the firm belief that they can never lose much. This is without even considering the additional fiscal stimulus that is in the offing.

This phenomenon is also evident for credit spreads. At this point, there is barely any difference in interest rates on low-risk and high-risk bonds, not only because central banks are also buying far riskier bonds, but also because the risks are not considered to be high.

It is not the case that the markets always do something different to what is expected in the event of broad consensus. But this does often happen. This is why we will discuss how the consensus could be off the mark this time.

The corona crisis and inflation

Historically, economists generally tend to extrapolate the past to the future. As a result, they often failed to foresee major changes. This could play a role again this time – but it is nowhere near certain. That is, central banks have had great difficulty avoiding deflation in the last decade, and this is why most economists believe this is unlikely to change for the time being. Certainly, now the scenario has been compounded by the corona crisis, which has triggered a significant decline in economic activity and inflation. The soaring debts will probably also ensure moderate economic growth for a long time to come, which is another reason not be concerned about inflation. In this climate, central banks can afford to pursue a very loose monetary policy for years to come without creating too much inflation. This accounts for the optimism about the performance of shares and credit spreads over the next couple of years.

We have our reservations about this line of reasoning. A remarkable aspect of the corona crisis is that it has blasted a hole in the demand side of the economy as well as in the supply side. A great many companies in all manner of sectors are basically bankrupt. This mainly includes restaurants, cinemas, theatres, concert organisers, artists and so on. Strangely enough, however, the number of bankruptcies in the US and Europe is currently lower than before the corona crisis. This is the result of the massive support packages which have been introduced by governments. However, nowhere near all of the support has been provided as a gift. A considerable proportion has been offered in the form of loans. Add to this the shock that many entrepreneurs have had to sustain, and it is quite likely that many companies will not expand/invest for the time being; even though they have shrunk considerably in order to cope with the corona crisis.

The demand side of the economy has also declined greatly. However, the financial position of most people has not deteriorated significantly. It is true that the unemployment rate has risen substantially, but the government has injected more money into the economy compared to the decline in incomes. However, consumers have saved up a far bigger proportion of the additional funds – partly to accumulate a buffer in these financially uncertain times, but also because they cannot spend money on eating out, going to the cinema and so on.

The positive story

However, this scenario could be turned upside down once a considerable proportion of the population has been vaccinated. We assume that the majority of healthcare workers, elderly and vulnerable people will have been vaccinated by the summer.

Chart 1: Sentiment is extremely bullish

Source: Refinitiv Datastream/ECR Research

This is why corona will lose its grip fairly quickly on the economy from the summer onwards (the demand side is likely to benefit more than the supply side).

In addition, central banks as well as governments do not want to take any risks. This is why massive fiscal stimulus programmes will be kept up for the time.

This positive picture will also be reflected in commodity prices. These have risen considerably due to an improving global economy and the expectation that the recovery will persist next year. All the more so because the Chinese economy is doing well again.

Our conclusion is therefore that it is quite likely the demand side of the economy will increase more than the supply side in the years ahead. This may well create higher inflation than generally anticipated at this point.

Back to the seventies?

If inflation in the West indeed rises sooner and more than expected, none of today’s positive predictions are on the mark. In this scenario, rising inflation expectations will lead to higher long-term interest rates than are currently priced. This will have a significant impact on the price-earnings ratios of shares, risk premiums and exchange rates. In this case, real interest rates could also rise.

In other words, this would come down to a return to the situation that was evident in the 1970s. At the time, the authorities were generally reluctant to crack down on inflation, as this would trigger a recession. Nowadays, the authorities are wary of countering inflation for fear of a collapse of the debt pile. However, it is generally argued that the central banks could still find a solution by setting caps for long-term interest rates. Once interest rates threaten to exceed these caps, the central bank will buy massive amounts of bonds – until interest rates fall back again (this is yield curve control).

As long as deflation is a major risk, this is certainly a viable option. However, it would only add fuel to the fire in the event of distinctly increasing inflation expectations, which would then rise even more rapidly. This would result in a massive supply of bonds at some point – to the extent where chaos erupts. This policy can therefore not be kept up for long.

In conclusion, it still cannot be ruled out that, next year, inflation and long-term interest rates will rise more than currently anticipated. This would have immediate negative consequences for shares, credit spreads and possibly also for gold for a while – especially in view of the major debt burden.

Chart 2: There hasn’t been an explosion in bankruptcies, this is due to extreme stimulus and credit support

Source: Refinitiv Datastream/ECR Research