As the U.S. endeavors to navigate out of the pandemic and into a recovery, questions remain about key factors, including COVID-19’s temporary and permanent effects on employment, the hope of achieving herd immunity, the unleashing of pent-up demand for goods and services as vaccinations rise, and the possibility of accelerating inflation. Investors have revised their expectations for economic growth in 2021-22 upward.
Yet the global pandemic remains persistent, and recent developments on that front have been mixed. As U.S. vaccinations escalated, the rise of highly contagious variants and limited vaccine access around the world contribute to unpredictability that makes for a challenging long-term outlook. Scientists have proven their ability to respond with medical advances—but with a time lag.
Major developments in economic and monetary policy could also affect market sentiment. The biggest factors that could impact the expansion include federal spending, the pace of economic growth, trending inflation and interest rates, and monetary policy responses to a possible overheating economy.
In this edition of Economic Commentary, Robert F. DeLucia, CFA and Consulting Economist for MEMBERS Capital Advisors, Inc., offers key insights into the dynamic and complex factors that impact the investment outlook for the coming 12 months and beyond. Here are some highlights:
- Equity prices and government bond yields trended higher in Q1, resulting in a wide divergence in returns on common stocks versus bonds.
- The passage of President Biden’s American Rescue Plan contributed to a sense of a looming economic boom, benefiting risk assets. Investors’ hope also rose on accelerating vaccinations and dipping U.S. infection and hospitalization rates.
- Shifts in relative performance were significant: Many non-U.S. equity markets outperformed the S&P 500, value stocks outperformed growth stocks, and small-cap stocks outperformed large-cap stocks.
- Economic prospects are favorable, but unpredictable economic and policy variables make the investment outlook for the next 12 months challenging. In addition to those challenges are valuation excesses in virtually all asset classes.
- Economic and investment cycles are less synchronized than normal. The equity market has already progressed to a stage well ahead of the unfolding business cycle. The implication is that future returns from a starting point of overvaluation could be below the long-term average.
- Government bonds have entered a bear market. That implies a rising trend in long-term interest rates throughout 2022, and possibly beyond. Rising bond yields are a long-term threat to the equity market, but may not interfere with the common stock bull market until real rates begin to impact the real economy.
- Inflation should remain under control until 2022, with a high likelihood of rising over the next three years—which would be an extreme negative for stocks, bonds, and the U.S. dollar.
- Inflationary depreciation of the U.S. dollar is supportive of domestic manufacturing and capital goods. It also spurs a shift from U.S. to non-U.S. global equity markets and from growth to value investment.
- Company earnings are expected to grow rapidly over the next two years. Even though the equity market is overvalued, stock prices tend to move higher in the short term as corporate earnings estimates continue trending upward.
- The Federal Reserve is not expected to begin a rate-tightening cycle until the economy approaches full employment.
- Massive government stimulus could contribute to an overheating economy, which could shorten the expansion cycle—or lead to a boom/bust cycle—which would be negative for equity returns beyond the next two years.
All opinions and commentaries expressed are those of the writer, Robert F. DeLucia, and do not necessarily reflect the opinions of CUNA Mutual Group, CBSI, or its management.
As this quarterly forecast shows, uncertainty remains a constant in a rapidly changing economic landscape with a great deal of potential for positive and negative impacts from multiple, divergent factors. And all that uncertainty can trigger fear, a powerful emotion that can lead to irrational and short-sighted decision-making, or push clients away from investing. But when clients anticipate their fear response and recognize they have investment options that address their individual risk tolerances, they may be more likely to stay invested.