Our Outlook for the Rest of 2021

Our base case largely hinges on health outcomes. Although the US and eurozone have in some cases paused their economic re-opening with partial lockdowns this winter we believe that the market will largely look-through the virus situation. We expect economic activity to continue to rebound, albeit slowly, on the back of supportive policy measures, generally improving business outlook and easy financial conditions.

With the wide-scale rollout of a vaccine in the first half of 2021, the second half of 2021 should see a surge in economic growth as pent-up demand flows through the economy. This should particularly benefit the service sector outside of North Asia and help all major regions see above-average growth in 2021. Despite the improved growth forecast, it should come without triggering a rise in interest rates, as plenty of spare capacity, elevated unemployment rate, and the Fed’s new inflation framework should put a ceiling on rates.

Thus, Central Banks are likely to keep interest rates low and remain accommodative as they support the post-pandemic economic recovery. Central Banks will also play a key role in mitigating risks by providing liquidity and keeping a lid on sharp rises to inflation. This is especially true as they use their new average inflation targeting framework, which may allow inflation to run above their 2% target in the short-term before settling out in a range of between 2.5% and 3.5%. It should be noted that we see a low likelihood that hyperinflation will emerge despite low-interest rates, stimulus, and other policy actions.

Sectors and regions that underperformed in 2020 are likely to play catch-up with the outperformers as a mean reversion opportunity exists coming into 2021. This backdrop leaves us bullish on stocks but less constructive on cash and some fixed-income investments due to their potential for earning negative real returns. Reasons for our bullishness on stocks include a resolution to COVID-19 that allows for an economic rebound to accelerate, increased consumer consumption aided by government stimulus and elevated savings rates, low costs of capital driving investments in technology and other assets that help rebuild depleted inventories, easy monetary and fiscal policy that may curtail risks, robust profit growth, and health equity earnings yields relative to US treasury yields, improving year-over-year corporate earnings off depressed 2020 results, and sizeable cash balances on the sidelines.

Amidst this backdrop, we see stocks outperforming fixed income and favor cyclical and small-cap stocks that benefit from the re-opening of face-to-face sectors, a steepening yield curve, fiscal stimulus, and attractive valuations. International stocks excluding the US are likely to outperform US equities in the short-term, driven by the composition of cyclical versus value, weaker US dollar, and relatively attractive valuations. However, this short-term opportunity should be taken with caution in the intermediate-term. Emerging market stocks are likely to outperform developed market stocks with improving sentiment, tailwinds from a weaker US dollar, and more attractive valuations. That said, select value stocks across all geographies face structural challenges that must be monitored.

Fixed income will continue to play a role in portfolios but with a gradually steepening yield curve and quantitative easing programs from central banks, some pockets of fixed income will be better positioned to perform than others. We especially like high yield sectors due to higher carry and moderate levels of spread compression.

Our fixed income outlook requires a rethink of fixed income portfolios because financial repression is a major threat. When we say financial repression, we are talking about a deliberate suppression of interest rates that generates inflation, higher than nominal interest rates, and is intended to lower debt servicing costs when government spending and debt loads grow larger. The consequences of this financial regime are large and can lead to transfers of wealth from bondholders to public and private borrowers, push capital toward intangible assets, and lower demand for investment capital. As a result, fixed-income investors must find new ways to generate income, especially as bonds continue facing numerous challenges including heightened duration risk, ultra-low yields, and inflation pressure.

Finally, we see attractive opportunities in both alternative asset classes and private investments. This is especially true because during periods of economic stress, liquidity premiums are high, and price dislocations can be abundant. To capitalize on this, accredited or qualified investors for whom private investments are suitable might look to private credit for distressed debt opportunities which may be ample hunting grounds as a wave of bankruptcies over the next 12 months is likely to present attractive investments. Additionally, in private equity, investors might consider investments in companies that own disruptive technologies that cannot be accessed via public markets. We also favor general partners (GP’s) who have a track record of maximizing operational leverage to widen margins even in environments revenue growth is hard to find. Similarly, real asset investments in select real estate and infrastructure sectors might add diversified sources of income, exposure to strong secular tailwinds, and lower volatility profiles. These are important, especially in today’s yield-starved world.

Before closing our outlook for 2021, we think it is important to acknowledge that we invest with respect for a range of possible outcomes. With that, we do see the potential for greater upside relative to our base case if we see more vaccines in the pipeline that prove effective and accelerate distribution, especially to developing countries, greater-than-expected fiscal stimulus, and a more robust global economic recovery. Conversely, more downside relative to our base case outlook might materialize if the virus continues to force lockdowns, vaccine distribution is slow, or fiscal and monetary stimulus prove inadequate. While these scenarios are not our base case, we believe investors must actively monitor markets and adjust their portfolios if warranted.

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