The last week’s market highlights:
Each week, we present our featured topics in the context of the major themes listed below from Nuveens 2021 Fourth-Quarter Outlook:
- U.S. economy: Stimulus wearing off but growth remains solid. More workers needed.
- Global economy: Slowing from its fastest pace in decades even as parts of Asia and the emerging markets are set to repen.
- Policy watch: Policy is shifting from “extremely accommodative” to merely “quite accommodative.”
- Fixed income: Income generation remains a challenge as rates rise gently from very low levels.
- Equities: Valuations have come down but remain high relative to history; earnings growth will be key to returns.
- Asset allocation: Balance the risk of hotter inflation with that of slower growth.
Quote of the week:
“80 percent of success is just showing up.” – Woody Allen
Nuveen’s Global Investment Committee: Fourth-quarter outlook
If you’re looking to make sense of the always-shifting financial markets and economic landscape, Nuveen’s Global Investment Committee (GIC) can help. This committee brings together the most senior investors from across the firm’s platform of core and specialist capabilities, including all public and private markets.
In our midyear outlook, we on the GIC pointed out that global growth was peaking and posed the question of what would come next. Well, now we know. As the reopening boom fades and global stimulus winds down, financial markets have entered a choppier environment in which investors who take a lot of risk may not receive a commensurate reward.
Let’s start with the good news: The global economic cycle is still young, with — we think — years of solid growth ahead. To illustrate:
- Unemployment rates are falling rapidly as people return to work.
- Inventories worldwide are being frantically restocked as producers catch up to the surprising surge in pent-up demand unleashed during the first half of the year.
- Residential and commercial real estate construction are cycling back up after a wobbly spring.
- Financial conditions are still quite loose thanks to easy monetary policy.
- Most importantly, consumers have emerged from the pandemic with plenty of cash and unusually strong balance sheets.
Now for the less good news:
- Most asset classes have become more expensive, as valuations have snapped back to their pre-COVID-19 levels. In fact, those for global equities and credit are higher now than they were before the pandemic.
The peak for global growth, even in the world’s largest economies, is now firmly in the rearview mirror, providing less of a macroeconomic tailwind. Our most important question for the balance of this year is: How will markets behave amid slowing demand growth in the context of fully valued asset prices?
Turning from inflation risks to growth risks
The Delta variant of COVID-19 has exacerbated the slowdowns already underway in the U.S. and Europe. More pressingly, it has delayed reopenings in areas like Asia and Latin America, where vaccinations have only recently ramped up. But Delta is not the primary factor driving down growth rates. Government stimulus played a huge role in sustaining household incomes and spending throughout 2020 and into 2021. In the U.S., for example, individual tax credits implemented as part of the CARES Act, signed into law in March 2020, were responsible for a nearly 7% net swing in income growth last year.2
Moving forward, we expect fiscal policy will actually start to be a drag on growth. The U.S. has borrowed nearly $6 trillion post the passage of the CARES Act. Even the most ambitious versions of the spending bills currently winding their way through Congress would maintain only a fraction of that borrowing rate. Much of the new spending seems likely to be offset by tax increases and other sources of revenue, and will be allocated over a much longer time period than other recent fiscal relief and stimulus packages, limiting its stimulative effect. Moreover, other countries haven’t matched the scope of U.S. government assistance during the pandemic, and they’re unlikely to do so now. The global trend is clearly toward less, not more, stimulus in the years ahead.
Meanwhile, monetary policy is primed to make a directionally similar, but far less dramatic, move from “extremely accommodative” to merely “quite accommodative” after central banks helped stabilize financial markets and created the loosest financial conditions in modern economic history. The winding down of quantitative easing and an eventual — though not imminent — rise in global policy rates should help allay inflation fears, which already appear to be declining.
The focus heading into 2022 may be on interest-rate hikes and the return of economic growth rates that equal or at least approach those from before the COVID-19 crisis. That environment could pose challenges to investors expecting the reflation trade to reignite and asset classes other than U.S. large- cap growth stocks to outperform. (Reflationary trades are bets that certain sectors of the market, such as small caps and value shares, will benefit more than large cap and growth names in an accelerating economic recovery.)
Interest-rate roller coaster decelerates
After a wild ride over the first half of 2021, interest-rate volatility has calmed down a bit. As the recovery moves forward, even at a slower pace, we still expect rates to move higher over the next six to 12 months. But the trajectory of the increase should be significantly flatter than it was in the first quarter of this year, when the yield on the 10-year U.S. Treasury note nearly doubled to 1.74%, a level from which it quickly descended and to which it has not come close to returning.3
While we believe the 10-year, which closed at 1.59% on October 15, could rise to that 1.7% range before year-end, income-focused investors have long given up on government bonds to adequately meet return and income objectives.4 Instead, credit-sensitive parts of the fixed income market, such as high yield bonds and senior loans — as well as dividend growth strategies in the equity market — have made more sense as sources of potential yield and income.
Still a long way to go
As the world reaches the light at the end of the pandemic tunnel, the road back to normal may have a few bumps. Chief among them are the struggles of global supply to match extremely high levels of demand, a dynamic that has led to bursts of inflation but also to record-high company profits.
At the same time, while the delicate removal of policy stimulus should help cool down inflationary heat, investors may want to look outside their asset allocation comfort zones to find better income and return opportunities. If the third quarter taught us anything, it’s that markets can remain resilient in the face of policy risks, and the opportunity cost of staying on the sidelines can still be high.