Virus, growth and policy.  These three words have been key in helping construct a proper portfolio allocation during the COVID-19 induced economic coma and subsequent market action.

 

How economies handled the pandemic, and the awe-inspiring medical effort to find vaccines within timelines generally unthinkable for this kind of situation, have greatly steered market action and influenced the pace of real economic recoveries.  However, once more, it was policy that truly dictated the rules of engagement.

As we enter into Phase 3 for the most promising vaccines and we witness growth coming back, albeit at a slowing pace, we must continue to look at policy - monetary especially but also fiscal - in order to make global asset allocation decisions.

 

At these new valuation levels and with growth still tentative in its comeback push, the support of monetary policy is key in justifying allocations to risky assets and more specifically in which assets.  The Fed is expected, at its upcoming September meeting, to formalize its new framework of "average inflation targeting," a solution which will allow the Central Bank to tolerate above-target inflation (the average would be calculated based on the undershooting that has occurred in recent times).

This approach, in a context of slowly returning growth, should favor equities over bonds and inflation hedges over very defensive assets.  This is the message we seem to be getting from markets, where the inflation break-evens in Treasury Inflation Protected Securities have shot up alongside massive rallies in gold and silver.

As far as fixed income, risk free paper does not seem so risk free from a long-term perspective, but it certainly still fits the bill of a risk diffuser in times of volatility. One such possibly dislocating time might be the upcoming presidential election which could be long, contested and overall ugly.

 

The Fed's stance alongside a deteriorating fiscal position also do not seem to set the foundations for a strong Dollar. This element might favor international exposure.

Therefore, to recap, portfolios should not be oblivious to the risk of an inflation overshooting in the next couple of years, bonds should be viewed as tactical volatility reducers, and investment grade credits should still be favored. As far as equities, global stocks with an emphasis on long-term trends such as biotechnology, robotics and some cyclical exposure should be looked at constructively.  Selective plays in real estate, internationally and domestically, may also help portfolios catch a cyclical rebound with a partial currency kicker. Volatility hedges in anticipation of the election should also be considered.