U.S. Economic Growth Projections
We believe the light at the end of the economic tunnel gets brighter by the day as vaccine deployment ramps-up and stimulus measures are approved. U.S. economic growth projected by the Philadelphia Fed’s Survey of Professional Forecasters is currently 4.5% for 2021. The annual projection is below that of other forecasters: Goldman Sachs expects 2021 U.S. Real GDP growth of 6.5% while JP Morgan is projecting growth of 6.2%. Regardless, projected U.S. economic growth is by far the best in decades. Most of this is attributable to the tremendous Federal stimulus and potential infrastructure spending with the added bonus of an increasing rate of vaccine deployment and increasing consumer mobility. Households have paid down debt and saved an estimated $1.6 trillion during the past year. Get Ready!
Inflation Expectation and Capital Markets
In capital markets much of the exuberance regarding the economic recovery is translating into higher inflation expectations and this has implications for both bond and equity investors. Historical analogues suggest that the large amount of liquidity to be injected into the economy and the constrained capacity under which many manufacturers and retailers are currently operating will create an inflationary environment–whether higher inflation is transitory or sustained is a topic of debate. Treasury market data indicates that the estimated inflation rate over the next 10 years is anticipated to be 2.3% on average. As a consequence, bond markets have seen yields rise with a commensurate decline in bond prices. Longer term this will lead to better investment yields as reinvested capital is made at higher yield levels, but that’s little solace for investors today. Historically, since 1980 the rolling two-year-returns of the Barclays U.S. Aggregated Bond Index have experienced few negative periods. With this minimum investment horizon, a “buy and hold” investor in the Barclays U.S. Aggregate only experienced a negative total return for a brief period in 2018. To be fair, historical yields were higher, which provided a bit of “cushion” to declining bond prices and this time could be different as real yields are currently negative and the historical cushion is non-existent.
Style and Market Cap Remains Important
Style and market capitalization allocation within equities will be important as we believe a rotation to value-style equities is underway and small caps are set to continue recent outperformance. Growth-style equities, particularly those companies with negative current cash flows and the expectations of positive future cash flows, have experienced volatility. Similar to longer duration bonds, the distant projected positive cash flows of growth companies are discounted more severely in a rate rising environment. This dynamic negatively impacts the net present value of growth companies (read as share price declines).
Conversely, value-style equities have held up relatively well and are leading growth-style investments for the year-to-date period. Value’s dominance is driven in part by the deployment of vaccines and the lifting of mobility and activity restrictions across the country. Additionally, earnings valuations of value-style indices entered the year far below that of growth-style indices, which provides a better entry point relative to growth-style indices and is compounded by the strong earning growth projections of value-style companies.
We expect small and midcap stocks (SMID) to perform well in 2021 as they have historically performed well during economic recoveries. As we collectively begin to see the pandemic in the rearview mirror and Washington implements the $1.9 trillion American Rescue Plan Act of 2021, we expect SMID caps to perform admirably.
In summary, despite the risks changing from a year ago, the fundamentals of asset allocation and risk management have not.
If you enjoyed this article, please join us for our Second Economic Outlook Webinar as we take a deeper dive into these topics with acclaimed Economist Dr. Mickey Levy from Berenberg Capital Markets on March 31, 2021 at 5pm EST