This commentary is an updated perspective of Our View Of 2021. To view the original assessment, click here.
Notes on Increasingly Optimistic> Labor Market & Consumer Sentiment
Our assessment of the labor market heading into the year proved largely accurate and we remain highly constructive on further developments through year-end. We have witnessed tremendous benefits tied to consumer spending, consumer sentiment, and aggregate consumer fiscal health, and we believe such trends have not yet matured. Their pace of improvement may likely shift lower as we head into August, and as schools reopen in-person, but the overall impact to growth should remain intact. Our focus will remain centered on aggregate job growth and adjustments to hourly earnings, all of which may provide further substance to the domestic inflationary landscape.
- It is important to note – once more – that the pandemic’s impact on the labor market was nothing short of historic last year. The pace, and magnitude, of job losses may have forever imprinted a lasting effect on how we perceive future risks to the labor market. What we also learned, however, is that each economic downturn can generate new and profound ways to sustain employment, which further supports the notion of avoiding direct comparisons across different recessions. Such was the case with the ‘work from home’ economy this time around. Although its lasting impact may marginally diminish, its influence will forever remain embedded within the labor market.
Notes on Increasingly Optimistic> Global Equity Markets
Our initial assessment of risk and return profiles for global equity markets proved supportive of our stance to maintain, or increase, global equity market participation in 2021. We must admit, however, that the general pace of gains has been notably stronger than anything we may have initially gauged. The return of the fiscally healthy consumer became apparent on a scale that few thought possible, which is once again a testament to how different the 2020 COVID bear market was relative to anything else in history.
- Our initial assessment for the potential of minimal volatility in 2021, including an allocation bias to midcap and small cap exposure in the U.S., has generated a positive attribution to total return. The notion of dismantled concentration within the large capitalization space has also materialized, as observed by the lack of extreme performance differentials between U.S. large cap value and U.S. large cap growth exposure. Stronger fundamentals have certainly contributed to such an observation as has exuberant short-term sentiment. Such sentiment has been attributed to positive consumer fiscal health, alongside their propensity to consume. Pent-up demand has generated tangible gains that have directly resulted in strong corporate earnings. Our assessment through year-end is one that continues to favor equity market participation, but perhaps in a more muted format. The momentum of upward earnings revisions is not something that can remain forever intact and that is a factor we are looking into through year-end. Marginal volatility may be possible following one of the strongest and unanticipated first half performance profiles in history.
Notes on Neutral> Interest rates
Our assessment on the likely path of market-driven interest rates alongside absent adjustments from the Federal Reserve, remains on track for 2021. Volatility in the ten-year yield has dominated bond markets through the first half of the year, as economic growth has notably surpassed expectations. As a result, traditional fixed income portfolios have failed to provide positive return profiles and have left many investors re-assessing their long-term effectiveness. The Federal Reserve has noted the strength in the economy, as well as in the housing market, and has indicated a potential monetary policy tightening plan for late 2022 or early 2023. We believe short-term transitory pressures on inflationary readings may have forced the Fed’s hand in releasing such information. It is possible that they may withhold on further promoting that message through year-end.
- The bottom line is that the Federal Reserve must raise interest rates amidst what may become an even stronger secular economic growth cycle over the next few years. To assume otherwise is an indication of recessionary pressures or some other factor that can cause notable economic downside. In our view, even in the potential presence of such a factor, the Federal Reserve will not push interest rates in negative territory, which may mean a continuation of poor performance from traditional fixed income portfolios across varying economic cycles.
Notes on Neutral > Global Economic Growth & Geopolitics
The unprecedented economic growth gains in the first half of 2021 yielded an outcome that reaffirms our assessment from late 2020. The notion of improved supply chains amidst one of the healthiest consumer profiles that we have witnessed in twenty-five years has provided an accelerated path to recovery. We continue to maintain a fundamental belief that 2021 growth rates will not surpass the absolute level of economic growth from last year, yet the estimated gains through year-end remain impressive. We do not yet know the annualized economic growth rate for the second quarter of 2021 (as of the release of this review), but we do know that the latest July estimate from the Atlanta Federal Reserve indicates a 7.9% growth rate. Although it will not be possible to maintain such momentum for the entirety of the year, any growth rate above 5% (in our view) will provide ample sentiment capacity.
- It is critical to note that we do not believe the economy and the equity market are likely to follow identical paths in the second half of the year. This should come as no surprise given that they are different in nature, both from a production, consumption, sentiment, and a leading indicator standpoint. We remain committed to our initial view on the economy, and we are likely to experience a short-term shift as we receive third quarter growth rates. We are anticipating a notably lower figure that the 7.9% estimate for the second quarter followed by what may transpire to be a stronger growth rate in the fourth quarter. This is likely a function of diminished consumer travel post-July, as most of the pent-up demand may have been witnessed. This will also be a function of schools reopening in-person. While we do not anticipate additional fiscal stimulus efforts, any potential stimulus is likely to only amplify consumer health.
- On the topic of geopolitics, our initial view of muted volatility, or uncertainty, because of foreign policy shifts under the Biden administration proved principally on-point. We continue to favor such a viewpoint through year-end.
Notes on Risk and Uncertainty> COVID-19
It is no secret that the prospects of a worsening COVID-19 landscape remained at the top of our risk list for 2021. The known unknowns, amidst the unknown unknowns, generated a level of uncertainty that no one claimed to effectively understand. What became apparent to us in December 2020, however, is that the probable nature of a similar equity market volatility profile as in 2020 remained miniscule. This was a function of vaccine development, maintained fiscal stimulus, and unfaltering consumer health. The added aid to sentiment was also apparent by the still strong work-from-home economy, a concept that defined the lack of sustained severity in the U.S. labor market. Broadly speaking, our retrospective analysis of the past six months, relative to our initial viewpoint, and assessed only on the premise of no COVID induced market volatility, proved largely accurate.
- The second half of the year continues to withhold similar known unknowns as those defined in the early part of the year. The latest COVID variant may once again impact supply chains and may disrupt the labor market, but the extent and severity of any potential disruption remains a key uncertainty. What we know – again – is that consumers are likely to sustain demand for goods and services in a way that can support estimated economic growth rates. This may also aid the potential for minimal equity market volatility. One component that is different this time around, however, is the notion of vaccinations as a way of reducing COVID’s impact, as defined by the Centers for Disease Control and Prevention (CDC). We now know that nearly 159 million Americans have been fully vaccinated, which may provide ample protection against most COVID variants, according to the CDC. We believe this is also likely to aid sentiment tied to economic growth and investors’ overall stance to maintain, or increase, equity market participation.
Notes on Risk and Uncertainty> U.S. Dollar and Congress
Our viewpoint on the U.S. dollar generated positive results on our allocation to dollar-hedged international exposure, albeit marginally. The impact to further gains on the dollar will likely be a function of stimulus efforts, monetary policy guidance, and general sentiment to U.S. risk assets relative to those across the globe. Any potential COVID variant will also help guide the path of the dollar, mainly as gauged by prospective supply chain issues. We believe that risks in this segment remain minimal through year-end, and we continue to favor a partial dollar hedge.
On the topic of Congressional seats, and overall political discussions following the Biden presidential win, the rhetoric has remained relatively quiet. This has occurred despite the notable media headlines in the early part of the year. Our initial assessment may have indicated a greater risk to markets in this segment, yet that is something that has not materialized. The main risk through year-end resides in the release of tax policy adjustments, many of which are not projected to be retrospective in nature. There is little to discuss on tax policy, at least as of now, given the lack of concrete information from the administration. We will provide more information as it becomes available.
Halftime assessment – through June 30th, 2021
Edison Byzyka, CFA – Chief Investment Officer
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. The economic forecasts set forth in the presentation may not develop as predicted and there can be no guarantee that strategies promoted will be successful. International investing involves special risks, such as currency fluctuation and political instability,
and may not be suitable for all investors. These risks are often heightened for investments in emerging markets. Investment advice offered through CX Institutional, a registered investment advisor.