2021 Q2 Global Investment Committee Outlook

View From the Top

Hi everyone. I'm Brian Nick, Chief Investment Strategist for Nuveen. Thanks so much for joining me today on LinkedIn live where I'll be recapping for you. The just concluded FOMC meeting for the month of March and then spending some time discussing a preview of what's going to be our second quarter outlook from the global investment committee at Nuveen which will cover the Federal Reserve, interest rates and inflation, but also a whole lot more. So what happened today? This was a big meeting for the Fed the first one in 2021, where they've had a chance to give us updated economic forecasts, a new statement a chance for Jay Powell to clarify some of the moves the Fed has been making over the last several months and indeed over the last year since the start of the pandemic, but it was also, I mean it has come on the heels of a lot of trepidation in the bond markets that spilled over into other markets as well, about how quickly interest rates ought to be rising, how quickly inflation might be creeping back into the picture.

So what did we learn today? Well, we learned that a central bank can be bullish and dovish at the same time. That's exactly the message that Fed tried to communicate today and we think they did so rather effectively. There was no change to actual monetary policy. Interest rates remain at zero asset purchases remained at a very robust, pays 120 billion dollars being bought by the Fed from the open market every month. And those two things don't seem likely to change for a considerable period of time a year or more in, in both cases. So that was widely expected. And the Federal Reserve’s statement also continues to strike a sober tone with respect to the damage done by the pandemic, the ongoing dislocation in the labor market and what could be a slow process back for a lot of industries that found themselves semi-permanently or permanently dislocated by COVID-19.

But the Fed statement did contain a bit more optimism as compared to the last one in January. They pointed out that economic indicators including labor market indicators have been turning up. So they made sure to indicate sort of in a, sort of a gradual way that things are improving as they see them in the general economic picture of the United States. The economic forecasts were really one of the most interesting parts of the meeting today. They were bullish across the board especially compared to just three months ago. The last time that the Fed had had a chance to share these with us. GDP growth forecast for 2021 from the Fed six and a half percent. First of all, that would be the fastest growth in a calendar year that we've had since the 1970s, actually on the low end of a lot of other consensus numbers from the private sector that we've been seeing over the last couple of months but that's up from 4.2% in December which was already a pretty robust positive forecast on the heels of a negative GDP print obviously in the year 2020. So already adding about 50% to their GDP growth forecast for 2021. Unemployment projected now to be four and a half percent by the end of this year. That's compared to five forecast just in the month of December and on its way down into the 3% range within the next year as well. Inflation they also see coming in higher over the next three years, this is really important because the Fed targets core inflation as one of their mandates.

They have inflation now coming in above or at their 2% target in 2021, 2022 and 2023. Now that might make you think that the Fed is on its way to raising interest rates after all the inflation rates are going to be 2.2% this year and the Fed's target is two. You might think the Fed is on its way to raising interest rates or tightening policy in some other way but that's not what the balance of the Fed statement and forecast show the dot plot, which is a kind of a colloquial way of saying the interest rate projections from the Federal Reserve individual members on the FOMC does not show any member who is, is willing or, or wants to raise interest rates in 2021. Only a handful of members that want to do so in 2022 and a minority of members that want to do so in 2023.

So you have a solid majority about 11 out of 18 FOMC members that want to keep interest rates at zero until 2024 at the earliest. That's an extremely dovish outlook considering all those other economic numbers I just threw at you having improved so much in terms of the forecast since the last FOMC meeting and the Fed is not alone here. We, and, and the balance of the investing and economic communities see much hotter GDP growth here in the United States than we would have projected just a few months ago. The Fed is always tweaking or clarifying its communication strategy but policy changes are unlikely for now. We don't think interest rates are going to go up. We agree with the Fed's assessment that they're not going to be going up until probably at the earliest the end of 2023, which would actually put it ahead of where the Fed currently forecast.

It's going to be at least a couple of years of zero interest rates, no asset purchase taper until perhaps the beginning of next year. And that taper ought to be gradual. So the Fed probably is going to be in the market buying assets at least until the end of next year although it may be doing so in diminished fashion as we move through 2022. That's still a lot of balance sheet accumulation on the way. This is really a new Fed. They announced last year that they were basically structurally more tolerant of inflation. Then they'd been in the past. They want to see inflation above their target to make up for all the time it's spent including right now below their 2% target. And so this symmetrical approach to monetary policy to inflation targeting is basically giving them a built-in excuse to ignore higher inflation readings for the time being some of which may be statistical quirks, some of which may be sort of growing pains, reopening, supply chain disruptions, weather related disruptions like we saw in the month of February.

They can basically ignore all that because inflation is basically a symmetrical goal now. Not just something they're targeting at a precise point at any given moment in time. And so that was really made clear by the Fed in this particular meeting they've revised up their inflation forecast but did not revise up their interest rate forecast. And that shows how much more dovish their reaction function has become how much more tolerant of inflation they become. And that's reflected in a lot of the bond market prices that we've seen. Why have interest rates been rising? For the most part they've been rising because inflation expectations that component of interest rates that compensates the investor for what it's expected to be inflation over the time that they're holding that bond. Those have now normalized and are probably a little bit above normal at this point especially over the shorter maturities.

Most of the inflation that the bottom market's expecting right now is on the shorter end zero to five years. Five to 10 years from now the bond market basically thinks inflation is going to be 2% again, but for the moment with the Fed that's targeting higher inflation with a lot of fuel still in the tank with respect to zero rates but also a lot of fiscal stimulus. This is really a big deal for the bond markets. And this is why you've seen the moves you've seen in interest rates lately because the bond market is basically once doubting the Fed's credibility which a little bit less so after today, I think but also saying well if the Fed's really going to stick to zero interest rates we may actually get some genuinely higher inflation over the next several quarters.

So the one thing I don't want to lose sight of in discussing the Fed sort of in this micro detail is that the economic picture for the US and most of the rest of the world has really brightened considerably since the last time we one of this on LinkedIn live. And certainly since we put our 2021 outlook together and released it to the public the name of that outlook was dark tunnel, bright light. I think it's fair to say that three months into the year that outlook is I think generally still valid, but we made our way through the tunnel to a considerable degree. So it's a shorter tunnel and the light is probably brighter than we would have expected, especially with respect to the degree of US fiscal stimulus that we've seen. Back in November and December. We couldn't have imagined that by the middle of March we'd see another close to two trillion dollars of fiscal stimulus passed here in the United States. The reason for that is that the, what made that possible what unlocked the potential for that to be able to move through Congress so quickly and be signed by the president was the elections that we saw in Georgia on January 5th, where you saw Democrats win two races not been wildly expected and basically tip the Senate to democratic control and basically created a much more streamlined process for a much larger fiscal package to make it through.

Jay Powell today in his comments mentioned that one of the reasons he expects things to proceed more quickly in terms of the economic improvement is that you have a very well-supported US consumer, US household right now, balance sheets, looking as strong as they ever have household net worth at an all-time high, income is at an all-time high savings rates north of 20%. As of the last month we had data for which is January. That's a very good position from which to start an economic reopening. It's going to happen somewhat organically as States remove their mitigation strategies. And as more people who become vaccinated or feel safer going out and participating in a more broad set of economic activities feel able to do so. So we're going to be seeing big things from economic growth in 2021, we're going to get maybe a quarter or two of double digit annualized economic growth.

Maybe the second and third quarter are going to be some of the best quarters we've ever seen for economic growth. And that's because of the reopening in addition to all the fiscal stimulus. So we're living in the upside scenario compared to what we would have expected just a few months ago. If we're thinking about the base case, the upside case and the downside case, I think we firmly moved into the upside case, which includes mostly good things like better corporate earnings, higher GDP growth, a better supported consumer, as I mentioned but also a few bad things like the potential or the risk of higher inflation which ends up pushing up interest rates. So the one area that we're also living in the upside scenario is in interest rates interest rates on the longer end in the United States and around the world are probably on the higher end of what we would have forecast coming into the year. Currently, the US ten-year Treasury note yields about 1.65%. That's up from below 1% at the start of the year. So a pretty swift increase in interest rates that comes with the kind of growth that we're expecting to see. So you do see some growing pains some adjustments within markets, some sectors like technology falling out of favor somewhat because there is a lot of discounting that goes on with the higher earnings growth that those companies are usually able to achieve. The higher, the interest rate, the less that earnings growth is worth to you in a year or two or three or four, versus some of the sectors like energy that performed exceedingly well this year. Financials industrials tend to be a bit more cyclical and revaluations are lower and have a chance to catch up to the rest of the market.

So we've certainly seen that happening but in the context of an overall increase in corporate profits growth that we're expecting to be even better than what's expected at the moment. So consensus is around 20% now for S&P 500 companies. It could be up to 30% by the end of the year if all goes well in the economy. The story may be shifting a bit though from a global synchronous recovery which is what we expected to start the year. So one that's really led by the US and that's because of the fiscal stimulus, but also because of the superior pace of vaccinations we're seeing in the United States compared specifically to the Eurozone where they've had a harder time getting started. That had a few issues with individual vaccines getting approved and getting shots in the arm. So the US could see a quicker reopening, fewer mitigation strategies, fewer restrictions on economic activity, and therefore get that that higher bounce and that quicker bounce that other parts of the world may not be getting.

But overall, by the end of this year we think we'll be in a rising tide environment which is going to tend to help all boats float to the top. So whether it's emerging markets, whether it's us small cap companies the parts of the markets that have done well so far this year that didn't do well last year we think are going to continue to have some of that momentum behind them. Interest rates and inflation may both rise from here. There's actually some good reasons to think inflation will take higher from here. Some statistical quirks in the data last year's numbers rolling off, replaced by this year's numbers. It doesn't necessarily mean investors need to worry about inflation or that the Fed is going to be worried about inflation, but we will see those numbers tick higher and that could lead to higher interest rates in the bond market over the short term.

But we think anything below 2% for a 10 year US Treasury note yield will be something the market can digest pretty easily. Certainly if that happens by the end of the year we think it's not going to be a problem at all. If it happens in the next couple of weeks, well that means we've seen another sharp increase in rates and probably some of the volatility in markets that goes along with it. We're also over the summer probably going to see some higher inflation because of supply chains trying to reconnect, businesses that are trying to reopen quickly in the face of sharp, rising demand people going out, taking trips, flying on planes, staying in hotels. A lot of those businesses have been dormant or semi dormant for many months now and are going to be trying to bring back workers very quickly, trying to get supplies to them very quickly through a lot of different places and a lot of different industries and all of that together may cause some price pressures in the near term, but we think supply can catch up to demand in those areas of the economy.

And therefore we're not at the beginning of inflationary spiral we're probably just going to see sort of a one-off which is exactly what the Fed forecast in its March statement of economic projections. Markets have certainly become much more sensitive to changes in interest rates the reaction function for just a few basis point move in the US tenure yield, I think has become more pronounced. We're seeing higher bond market volatility. Than we would, otherwise, as I said, tech has moved out of favor just a bit because it's becomes sort of longer duration asset that can vary sensitive to changes in interest rates relative to the rest of the equity market. But that's come in the context of a market that continues to make all time high. So it's been other sectors that have picked up the baton and sort of run with it compared to technology which was clearly the outperformer last year and really over the course of the last decade.

So we're probably incrementally shifting portfolio weights towards those other sectors as we've been doing for most of the past year, but from a place where we've been all the way to technology prior to that. So we're not making huge changes in portfolios from growth to value or from US large cap to US small cap. But I think on the margin, you can say we're more overweight or less underweight those areas of the, of the equity market than we were again just a few months ago. Real assets also have to be a part of the conversation when you're talking about inflation, rising interest rates, rising global GDP growth. A farmland we think can be sort of a durable source of real income because you have that inflation component baked into the prices of what's being grown and sold. Green infrastructure, financing green energy projects.

Again, it can be these high yielding options for investors while, you know sticking to those values that we have in in terms of responsible investing and ESG, environmental, social, governing investing. Those are also that we think there's opportunities but also opportunities for yield for income focused investors. And then US housing, generally, even both the public and private infrastructure areas because there's this pent up demand. That's finally coming to the market for people wanting to move to a place where they have more space, maybe moving out of a cities in some cases moving to other parts of the country. There's this just this boom going on in terms of home construction helped by the low interest rate environment that we're in. And we think being invested in that sector also makes a good deal of sense. So, I will wrap it up there.

And once again the Fed meeting today really reinforces our view that very good times, lie ahead for the economy. And the Federal Reserve is not going to be the culprit that eventually brings the economy or the economic growth that we're going to be enjoying this year to a premature end. And in the reaction function from the Fed has become much more dovish. You saw that today in the forecast that the Fed is, is holding itself to but because the markets can incorporate a lot of this news already have quite quickly or really throughout most of the second half of last year investors may not be as handsomely rewarded for being in a diversified portfolios this year as they were last year, because last year is when a lot of the good news about the vaccine, about the stimulus really came in into the headlines.

And so a lot of the markets were able to pull forward that good news from last year into this year. So perhaps not expecting as great things from a diversified portfolio including credit sensitive bonds, income or interest rate sensitive bonds, equities, real assets, real estate all those things together. We think produce a good return this year but not a great return like we had in 2020. So on that bittersweet note, I think I'll close this LinkedIn live session. Once again my name is Brian Nick, chief investment strategist for Nuveen look out for our second quarter outlook from our global investment committee in the week of March 29th. Thanks very much for being with me.

Viewpoints from the Global Investment Committee

2Q | 2021 outlook
 
Our initial 2021 outlook featured the theme “Dark tunnel. Bright light,” as a way to indicate that while we saw a strong possibility for economic and market upside, we also thought the path to get there would be difficult. And while the global pandemic remains a humanitarian crisis, that upside scenario is happening more quickly than we expected. That’s good news, in some ways, but also brings with it different risks and challenges. As we move closer to the end of the tunnel, Nuveen’s Global Investment Committee still sees opportunities across asset classes and remains committed to offering our clients ideas for how to navigate financial markets for today and tomorrow.
 
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