2021 Mid-Year Outlook
Economic recovery, updated vaccine and portfolio considerations
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- Financial market returns year to date reflect the expanding global economic recovery. Economic momentum and a robust earnings backdrop underpin uniformly positive global equity returns while this same strength has been the impetus for gyrations in interest rates, hampering fixed income returns.
- Our baseline view is that the global economic revival is well underway but its relative strength may be shifting overseas, particularly to the Eurozone, where amplifying vaccination efforts and the prospects for additional stimulus reign.
- Our case for thoughtful risk-taking remains intact. While the historically sharp and compressed pace of the recovery has spurred exceptionally strong returns across many segments of the capital markets and elevated valuations, the economic expansion should continue apace, fueled by still highly accommodative stimulus, reopening impetus and broader vaccination.
Financial Market Conditions
Forecasts for global economic growth in 2021 and 2022 remain robust with the World Bank projecting a 5.6 percent growth rate for 2021 and a 4.3 percent rate in 2022. If achieved, this recovery pace would be the most rapid from crisis conditions in some 80 years and suggests the extraordinary levels of stimulus applied to the recovery and the herculean efforts to develop and distribute vaccines are justified.
GDP Growth Rates
While the case for further global economic growth remains compelling, we are mindful that near-term base effect comparisons and a bifurcated pattern of growth may be masking some complexities of the recovery. It is anticipated that by year-end 2021 global output will still be about 2 percent below its pre-pandemic level with many countries not fully recovering output until 2023.
While a narrative centering on the potential for heightened inflation has taken hold among investors, the Federal Reserve (Fed) left its existing (and highly accommodative) rate policy and asset purchasing program unchanged at its June meeting. Of note, 13 of the 18 governors now anticipate at least one rate hike being necessary by the end of 2023. Headlines focus on the shorter time framer versus prior guidance, but 2023 represents a very long and visible runway and hardly reflects a sudden Fed pivot due to critical inflation concerns. Monetary policy elsewhere around the world, on balance, remains stimulative as authorities seek to strike a balance between fostering economic repairs and their respective policy objectives.
Governments across the globe unleashed unprecedented amounts of fiscal stimulus in the immediate aftermath of the pandemic’s onset and measures of additional potential support persist. President Biden’s late-May announcement outlining upwards of $6 trillion of supplemental spending serves as the readiest evidence of this pledge. However, we expect the global fiscal response, considered collectively, has likely peaked and that further efforts to initiate stimulus via these channels may prove to be less impactful. In our view, fiscal largesse retains the capacity to vitalize economic activity in the near-term, but investors should be alert to the possibility that the longer-term impacts of wide scale spending can serve as a headwind to economic growth.
Perhaps no topic has garnered a higher level of financial press and investor attention than inflation over the last few months. A global economy under rapid repair resulted in supply chain disruptions and notably higher input prices, fueling speculation that inflation may be on an accelerated trajectory to outpace the Fed’s longstanding 2 percent target. However, more recent moderations in raw material prices, for example, suggest some of these pressures are beginning to alleviate as organizations undertake the steps necessary to recalibrate their operations. We accept the Fed’s premise that inflation is likely to run at a meaningfully elevated level in the near term before ultimately settling at a higher-than-pre-pandemic level, but at a rate that should not threaten the global recovery.
The Fed’s recent more hawkish tone, while very preliminary and measured, has resulted in a bout of U.S. dollar strength despite the greenback’s somewhat lofty valuation and the geographically broadening economic recovery on display. Otherwise, the dollar was trending weaker for much of the second quarter. Absent a material flight to quality/risk-off market event, we expect the dollar to be range-bound, taking its directional cues from developments on the global economic front and the policy responses devised by authorities to mitigate, what are certain to be, differentiated paths to recovery.
Investment Themes for 2021 – Mid-Year Updates
We began the year with the general adage that investors would be compensated for bearing thoughtful measures of risk and this stance has, by and large, proven to be a rewarding posture for investors. In our view, prudent risk-taking will continue to be beneficial to investors in the second half of the year. The still potent forces of stimulus and steady gains on the vaccination front continue to encourage reopening plans worldwide but not yet to a beyond a mid-cycle recovery. Capital market returns can still be robust at this stage of the cycle and investors should position themselves accordingly.
1. The Pandemic’s Wake
Mid-Year Observation & Portfolio Impact
At the beginning of the year, we held firm to the notion that an improving global economy, drawing momentum from both stimulus and escalating vaccine distribution, could provide the foundation for a broader pattern of asset class returns. As evidenced in the graph below, this pattern has largely come to pass with small capitalization and value stocks (and other asset classes more directly linked to an economic reawakening) providing return advantages year to date over the “stay-at-home” stocks that led the performance rolls as markets regained their footing in the spring of 2020.
Despite the recent improvement, the path the economy will take to full recovery remains uncertain. While we do suggest investors looking to tilt their portfolio exposures lean modestly towards cyclical and value-oriented stocks, broad diversification across and within asset classes remains the most effective tool by which investors can steer through this uncertainty.
2. Opportunities in a Low Interest Rate Environment
Mid-Year Observation & Portfolio Impact
We began the year with the baseline recognition that very low interest rates would render fixed income investing challenging in the near-term. This expectation has come to pass as evidenced by the muted returns experienced across the broad fixed income markets year-to-date. While interest rates more recently have settled a touch lower, they elevated meaningfully earlier in the year as economic momentum built. However, yields available across the entirety of the maturity spectrum continue to hover near historic lows and, once again, center our expectations toward modest near-term bond returns. Moreover, the incremental yields (“spreads” in market parlance) available across many non-Treasury securities remain at compressed levels.
We expect investing conditions in the fixed income arena to remain challenged in the second half of the year. Dynamic bond strategies continue to resonate with us as an effective means by which to respond to these challenges. As we suggested at the beginning of the year, investing with a nimble mindset and an enhanced appreciation of selectivity will again remain important guideposts for fixed income investing in the coming months.
3. A Case for Global Equity Exposure
Mid-Year Observation & Portfolio Impact
International equities have demonstrated pockets of strength year to date (May being the most recent example) and we reiterate our stance that they have an important and rightful role to play when constructing a portfolio. Their relatively modest valuations offer a measure of protection versus more elevated domestic equity valuations and, as we indicated at the beginning of the year, their pro-cyclical composition leverages more directly to a materially improving economic backdrop, particularly within the Eurozone where stimulus efforts are robust and re-openings are accelerating.
A range-bound U.S. dollar and a stabilizing commodity complex may lend additional measures of support to foreign equities through the balance of the year.
4. Returns from Real Assets
Mid-Year Observation & Portfolio Impact
At the beginning of the year, we outlined that subdued inflation metrics had been the recurring norm for quite some time as the effects of globalization, improved productivity and U.S. dollar strength conspired to keep price levels in check and below the stated Fed target rate of 2 percent. At the same time, we championed the idea that the dynamics around inflation and the factors that influence it were in transition and could nudge inflation higher. Specifically, we suggested that the consolidated effect of monetary and fiscal policy meaningfully elevated the possibility of higher inflation and that has, indeed, transpired year to date. Performance of commodities and tangible assets have responded in kind, validating our beginning-of-the-year-view that an allocation to a diversified stream of real assets had a role in a thoughtfully constructed portfolio. Current considerations on the inflation front continue to support a dedicated real asset allocation for the intermediate term/foreseeable future, in our view.
Investing conditions remain advantageous, in our opinion, as we enter the second half of the year, yet we are mindful that the very sharp recoveries of the economy and many markets will require heightened investor vigilance. We expect periodic bouts of increased market volatility through the remainder of the year. However, an ongoing global economic recovery, the beneficial influences of still highly accommodative stimulus, and the steady pace of reopenings worldwide, when synchronized, inform our constructive view for the balance of the year and our case for thoughtful risk asset exposure is unchanged.
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