The law of diminishing returns

Central banks to the rescue. We warned three months about a flock of doves re-turning to the markets. Their return has proved bullish for corporate bonds and equi-ties, as we expected, and vindicated our recommendation to cut exposure to cash.


  • Central banks are about to press the ‘easing’ button again. But the likes of the ECB and BoJ are facing the law of di-minishing return, i.e. it is not clear that their actions will effectively re-anchor inflation expectations at higher levels. If, by cutting rates to negative and buying loads of assets they have not succeeded, why would they now?
  • With bond yields going lower for longer, investors too face the tough reality of diminishing returns. A record amount of bonds trade below zero (YTM), and the hunt for yield is raging. Except for those predicting a global downturn – we don’t – the investment choices are clear: equities and credit remain preferred habitat.
  • Most importantly the US economy is starting to wobble. This is both a concern and a blessing. As President Trump realises that tariffs are causing self-inflicted pain, he is likely to turn less aggressive as he prepares for the US presi-dential election, in just a bit more than one year. This, and reflation policies, should keep the global economy afloat.
  • If tariffs don’t work, why not trying a currency war? We are bearish the USD, and that should be good news to EM markets.

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US President-elect Joe Biden has unveiled a $1.9 trillion stimulus package proposal. Following the recent increase in cases, China has imposed new restrictions and lockdowns in the Hebei province. Canada has implemented new restrictions and a provincewide curfew in Quebec that will last until February 8. German Chancellor Angela Merkel warned that the recent rise in Covid-19 cases could force the country to prolong the nationwide lockdown until April.
Following a monster rally in stocks last autumn, multiples are well above historical averages, but equity investors can count on lingering low yields, tighter credit spreads and increasing central banks’ balance sheets which in turn maintain low the cost of equity and the discount rate of future cash flows.
Video Outlook 2021: Repair and Despair
Watch the Outlook video with Vincent Chaigneau, Head of Research at Generali Investments