2021 Midyear Outlook: Navigating through the recovery
Listen in as we discuss our outlook on the US recovery and the Federal Reserve’s new framework, including its impact on inflation, interest rates and growth.
One of the key tenants for our 2021 investment outlook is the idea that cycles matter. We believe 2020 was a decisive end to the prior cycle and we are at the beginning of a new business cycle, which is being fueled by unprecedented stimulus, both monetary and fiscal, in the U.S. and globally. Rising COVID-19 vaccination rates and reopening economies should likely add further tailwinds to the market. We believe there is meaningful upside to consensus earnings expectations for the S&P 500 Index at this time and investors should be fully invested.
Business cycles can be broken down into four phases: recovery, expansion, excess and contraction. As a new cycle begins, the economy moves from the contraction phase into the recovery phase, which is where we believe we are right now. As the economy moves through the recovery phase and into the early part of the expansion phase, interest rates are low, and growth is accelerating. As the economy nears the excess phase of the cycle, growth is at its highest rate, but imbalances begin to appear, and the economy often overheats. These excesses often provoke central banks to raise rates to a point economic growth is choked off. The economy then enters a contraction phase, with growth and employment falling, before finally coming full circle back to recovery.
In the words of John Templeton, “Bull markets are born on pessimism, grow on skepticism, mature on optimism and die on euphoria.” The longest bull market on record, which commenced in the depths of the Global Financial Crisis (2007-2009), came to a decisive end during the pandemic-related downturn of 2020. Skeptics observe the market is now at new highs, whereas following prior recessions, the average full market recovery took two years. We concur with the expectation that the current market recovery is likely to be robust, especially because the severity of the 2020 downturn bodes well for a sustained period of economic expansion. Should these conditions be realized, we anticipate a long runway of business growth, and thereby market and investment opportunities.
As previously stated, we believe we’re in the recovery phase at the start of a new cycle, as the economy continues to recover from 2020’s pandemic-induced recession. While the economy is now expanding, certain segments of the economy remain significantly impacted by restrictions related to COVID-19. When service industries like restaurants, travel and entertainment begin to open up, we think we’ll see another significant move higher in economic growth as we move into the expansion phase of the cycle. Further, manufacturing should see continued momentum as businesses work to rebuild lean inventories.
One of the reasons we are so confident in the recovery is the remarkable amount of stimulus being pumped into the economy. Looking at the U.S. since last year, the Cares Act in March exceeded $2 trillion. In December, Congress approved an additional $900 billion in stimulus. Currently, Congress and the Biden administration are working on a $1.9 trillion stimulus bill. In addition, there is talk in Washington of a $2 trillion infrastructure bill later this year, which would be spread out over four years. On the fiscal side of the equation, the amount of money that is flowing into the economy and into consumer pocketbooks is very stimulative for the economy and it is set to continue for the foreseeable future.
On the monetary front, the Federal Reserve (Fed) is doing its part as well. In addition to taking rates to zero and doing some emergency lending into the economy early in the crisis, the U.S. central bank continues to pursue quantitative easing (QE) by purchasing $80 billion per month in treasuries and $40 billion per month in mortgage backed securities. In the past year alone, the Fed’s balance sheet has grown by $3.5 trillion versus $2.5 trillion in the four years after the Global Financial Crisis and will likely add more than $1 trillion throughout 2021. Given the combination of unprecedented amounts of fiscal and monetary stimulus, we are expecting annual gross domestic product (GDP) growth of around 7.0% in the U.S., which would be the highest in 37 years.
Source: Ivy Investments, Macrobond. Chart shows Federal Reserve quantitative easing purchases of government bonds and other instruments and U.S. fiscal stimulus 2007–2020. Shadowed area represents the Great Financial Crisis era. Past performance is not a guarantee of future results.
In addition, we forecast global GDP growth around 7.0% in 2021. Again, the extraordinary amount of stimulus is the key driver in the growth rebound. It took several years for the economy to get back to pre-crisis levels following the Global Financial Crisis that began in 2008. However, we are expecting a return to pre-pandemic levels of economic activity as soon as the second or third quarter of this year.
Source: Ivy Investments, Macrobond. Chart shows global industrial production and the number of countries with declining inventories by percentage, 2008–2020. The Manufacturing Purchasing Managers’ Index (PMI) is a measure of the prevailing direction of economic trends in manufacturing. The PMI is based on a monthly survey of supply chain managers across 19 industries. Past performance is not a guarantee of future results.
The economic cycle that ended last year was the longest expansion in history at 128 months. We think its record duration was a function of the very low growth rates throughout the cycle. The low growth rates helped keep interest rates low, spreading the cycle out for an extended period. Given the amount of stimulus we’ve seen and are likely to see in the quarters ahead, we believe we’ll likely reach the peak phase of the cycle sooner than we did in the last cycle. This would mean the Fed would likely raise rates to cool the economy earlier than the market was anticipating a year ago as the pandemic unfolded.
Cycles do matter for investing and we believe we are early in a recovery phase that is set to accelerate. That acceleration will be fueled by fiscal and monetary stimulus, but also by economies reopening around the globe as the number of vaccinations continues to climb. While we do not know exactly how this cycle will play out, we have high confidence that these meaningful tailwinds will continue to drive improved economic fundamentals. This is a phase of the cycle when the opportunity costs of sitting on the sidelines are high. One of the benefits of owning risk assets throughout a cycle is the potential for compounding long-term returns. We believe active investing and engagement are crucial to realizing this goal.
Past performance is not a guarantee of future results. This information is not meant as investment advice or to predict or project the future performance of any investment product. The opinions are current through Feb. 19, 2021, are subject to change at any time based on market and other current conditions, and no forecasts can be guaranteed. This information is being provided as a general source of information and is not intended as a recommendation to purchase, sell, or hold any specific security or to engage in any investment strategy. Investment decisions should always be made based on an investor’s specific objectives, financial needs, risk tolerance and time horizon.
Risk factors: Investing involves risk and the potential to lose principal. Fixed-income securities are subject to interest rate risk and, as such, the value of such securities may fall as interest rates rise. International investing involves additional risks, including currency fluctuations, political or economic conditions affecting the foreign country, and differences in accounting standards and foreign regulations. These risks are magnified in emerging markets.
The S&P 500® Index is a float-adjusted market capitalization weighted index that measures the large-capitalization of the U.S. equity market. It is not possible to invest directly in an index.
The impact of COVID-19, and other infectious illness outbreaks that may arise in the future, could adversely affect the economies of many nations or the entire global economy, individual issuers and capital markets in ways that cannot necessarily be foreseen. In addition, the impact of infectious illnesses in emerging market countries may be greater due to generally less established healthcare systems. Public health crises caused by the COVID-19 outbreak may exacerbate other pre-existing political, social and economic risks in certain countries or globally. The duration of the COVID-19 outbreak and its effects cannot be determined with certainty.