The last week’s market highlights:
Each week, we present our featured topics in the context of the major themes listed below from Nuveen’s 2021 Outlook:
- U.S. economy: Getting worse before it improves.
- Global economy: Ready to get back to normal—with the help of vaccines.
- Policy watch: No Federal Reserve interest-rate hikes until at least 2023.
- Fixed income: A modest-risk overweight with a focus on credit sectors.
- Equities: Lean toward small caps, emerging market shares and dividend payers.
- Asset allocation: Consider benefits of active management amid idiosyncratic opportunities.
Quote of the week:
“Every moment is a fresh beginning.” – T.S. Elliot
China’s economy accelerated in the fourth quarter. How will the U.S. fare?
Last week, China reported that its economy grew 2.3% for 2020 as a whole and 6.5% in the fourth quarter versus a year ago. The 6.5% figure is in line with, and even a bit higher than, year-over-year growth rates prior to the COVID-19 crisis.3
While China’s recovery seems impressive on its face considering the pandemic, we think there’s a catch: much of the rebound can be attributed to state-sponsored manufacturing. Beijing frequently offers cheap land to factory owners or provides loans to businesses at favorable interest rates. So the government can turn on the economic switches when it wants to boost growth.
But the government can’t force people to spend money. Retail sales are still down 3.9% since 2019 despite China’s ”head start” in confronting the virus more than a year ago, and thus its longer runway to recovery. Excluding autos, the decline in retail sales was modestly larger at 4.1%.4 If China’s economy were structured like that of the U.S., where consumption makes up over 70% of GDP, its latest growth report card would appear less favorable, as consumer spending represents a smaller percentage of China’s output.
It’s clear that China is a manufacturing powerhouse and that its economy stands to benefit as global manufacturing continues to hum along. But looking ahead, we see two sources of concern. First, will Chinese consumers open their wallets and spend more? And second, will China’s customers—the U.S. and Europe, for example—stage a quick economic recovery, fueling a rise in Chinese exports? How these questions are resolved will determine whether China is able to stay ahead of the economic curve, or whether it quickly resumes the managed structural deceleration its economy was experiencing before 2020.
Another factor in China’s economic outlook will be Beijing’s relationship with the Biden administration. The new U.S. president may talk a more diplomatic game on trade and seek broader constructive ties with China, but it’s too early to tell which of former President Trump’s policies, if any, he intends to amend or reverse. This means the adversarial nature of U.S./China relations over the past four years could endure, albeit with fewer Twitter outbursts and less unexpected, market-moving news.
Turning to the U.S. economy, the government will release its advance estimate of fourth-quarter GDP growth on Thursday. Forecasts vary greatly, from as low as 2.6% (annualized) from the New York Fed’s NowCast model to as high as 7.5% (annualized) from The Atlanta Fed’s GDPNow Tracker.5 We’re confident the result will be well below the third quarter rate of 33.4%, as key components of the U.S. economy have cooled due to surging COVID-19 cases late in the year.5 For example:
- Retail sales fell in December for the third straight month.6
- The labor market has lost steam after building momentum last summer. In November, job creation badly missed forecasts, and in December, the economy shed 140,000 payrolls – marking the first month of job losses since April. All told, over 15 million people remain on unemployment assistance.7
In contrast, economic bright spots include:
- The housing market, as December housing starts hit their highest level since 2006 and building permits surged, suggesting more construction ahead.
- Manufacturing activity, which last month hit its highest level in more than two years.8
- Industrial production, up 3% in the fourth quarter.9
Trade represents a wild card for fourth-quarter GDP, given the disparate levels of economic distress around the world and wobbly U.S. consumer demand in the ongoing stay-at-home environment. Among the likely detractors from GDP will be net exports. We think import growth likely exceeded export growth during the quarter — despite a broad drop in the U.S. dollar versus other currencies, which makes imports more expensive.
Not much news from the ECB last week. Expect the same from the Fed.
This Wednesday, the Federal Reserve will hold its first meeting of 2021, just one month after Congress passed a $900 billion economic relief package. That injection of fiscal stimulus should calm some nerves at the Fed, which for months has been calling for more federal spending to bolster the economy’s continued recovery from its coronavirus-driven downturn.
Also likely to be of comfort to Fed Chair Jerome Powell and his colleagues: the impending confirmation of former Fed Chair Janet Yellen as U.S. Treasury Secretary under President Biden. Yellen is expected to champion the new administration’s proposal for a further $1.9 trillion in economic aid — including various measures of both temporary and structural support for low income households — to combat the pandemic’s devastating impacts.
At his upcoming press conference, Powell will likely be pressed about the Fed’s next steps in the event the full fiscal measure passes and heats up the economy faster than the Fed currently anticipates, potentially resulting in higher-than-desirable inflation. (The Fed’s most recent forecast is for inflation to hit 1.8% and 1.9% in 2021 and 2022, respectively — below its 2% target.10)
How might Powell react? We believe he’ll express optimism about the economy while continuing to emphasize that any Fed policy moves will be data-driven. And there’s virtually no chance he’ll commit to rethinking the Fed’s ultra-dovish stance. That means he’ll take pains to avoid suggesting there are any plans to end the current quantitative easing (QE) asset-purchase program before the Fed’s goals for employment and inflation are met. Nor will he offer any hint that the Fed is considering raising short-term interest rates from their current 0%-0.25% range any time soon. Either utterance would rattle markets, sending longer-dated Treasury yields higher, stock prices lower and credit spreads wider — similar to what happened during the “taper tantrum” of 2013.
The Fed’s meeting follows on the heels of the first 2021 meeting of the European Central Bank (ECB), held last Thursday, at which ECB President Christine Lagarde announced few changes to the ECB’s current monetary policy. The lack of headline news wasn’t surprising, given the ECB’s December decision to continue offering ultra-low-interest-rate loans to banks and to expand its pandemic emergency purchase program (PEPP) — the ECB’s version of QE — from €1.35 trillion to €1.85 trillion. But investors seemed to key in on a slight change of wording in the ECB’s policy statement indicating that the full PEPP package may be unnecessary if a lower amount can facilitate favorable financing conditions. This tweak was probably a nod to ECB members who are skeptical of QE in the first place.
There were no big market swings in the wake of the ECB meeting. The rise of the euro against the U.S. dollar has slowed in recent weeks. Meanwhile, emerging-market (EM) currencies and other risk assets have continued to appreciate on the prospect of a global recovery this year, COVID-19 vaccine rollouts and even more economic stimulus.