Animal spirits, declinism, and policy choices that will impact asset allocation

There will be significant work published on what should be the right asset allocation for 2021. I read as many of these pieces as I can get my hands on.  There is a simple question for US investors tied to these forecasts that moves beyond COVID and economic policies. Do you have optimist or pessimist view on US economic and political prospects beyond the COVID recovery?

Given the high level of uncertainty, this question can be phrased differently. Should you have positive animal spirits, as described by Keynes, to invest and spend even in an unknown world, or should you take a defensive posture based on economic weakness and US pessimism? 

Beyond the policy tactics of vaccines and lockdown reversals that will affect market expectations, investment allocations should be based on optimistic or pessimistic animal spirits and what is the process and policy choices that will get the economy to a more positive state. This positive state is tied closely with the broad political view of US declinism and pessimism concerning its preeminent status in the global economy and world affairs. The path for a correction to declinism will drive longer-term US optimism. (See "The China Challenge Can Help America Avert Decline: Why Competition Could Prove Declinists Wrong Again" in Foreign Affairs for a general discussion of declinism.)

  

For Keynes, markets are often driven by animal spirits, the optimism or pessimism that exists when the future is highly uncertainty. When uncertainty is high, the normal tools of valuation and analysis are ineffective. Investors just don't know and have to rely on their feeling of optimism or pessimism. In a depression or recession, pessimistic animal spirits drive decisions. A recovery occurs when sentiment changes to optimism. There is no question there is a current sense of financial optimism; however, this euphoria may not be matched in the real economy. More optimistic animal spirits will drive the US economy beyond catch-up to long-term growth. 

Declinism, the belief that the United States is sliding irreversibly from its preeminent status, has been a major theme of the last four year and will be the key theme for the next four years especially if there is a desire for stronger long-term growth. Declinism talk started much earlier but has swept into the general political discussion in more tangible and extreme forms of political choice.  

The declinism solution is centered between two extremes for policy. One position has been it can be arrested through unilateralism and a reversal of the liberal globalist order. The alternative position also believes declinism is caused by inequality and a lack of global cooperation that needs to be addressed through social and economic restructuring and the rule of international law and cooperation. Both argue for a change in the behavior and structure of the United States; nevertheless,  the choice of direction will impact the longer-term pricing of financial assets and the potential for sustained growth. 

Investor allocations will be making a choice on whether declinism can be reversed and the policy form necessary for the reversal. The success of risk-on asset allocation will be determined by the declinism solution accepted by the public and how that path forward will improve both the US and the global economy. Any end of declinism will be coupled with a sense of optimism that problems can be overcome and that investment will be rewarded and productivity enhanced; however, the policy choices will impact the form and placement of the optimism. Investor should consider alternative declinism solution paths.  

This discussion may be an abstraction, but sustained financial gains needs to be coupled with a robust economy that moves beyond a story of COVID recovery.