2021 Q4 Outlook2021Q4Outlook

2021 has generally been a “risk on” year with developed market equities delivering strong performance that has beaten the returns on global bonds by a large margin. With a strong US recovery—in both the economy and corporate earnings—low policy rates and ongoing asset purchases by the Federal Reserve, US equities have been particularly strong performers with both US REITs and broader US equities leading among the major market indices.

Economic Outlook

• A robust global recovery from the pandemic-induced downturn continues despite signs that economic activity hit a speed bump in Q3, from the COVID-19 Delta variant spreading around the world. Renewed lockdowns in certain countries and more cautious behavior among consumers are pushing down Q3 growth expectations from earlier estimates and from Q2’s torrid pace.
• As the Delta variant recedes, we expect a growth reacceleration into year end. The Delta variant is likely to represent a temporary hit to growth that won’t prevent a solid global economic expansion from continuing in 2022.
• Given Delta variant headwinds, US GDP growth should see a slowdown in Q3 from the 6.6% annualized pace in Q2. In contrast, Eurozone GDP growth is expected to strengthen to a double-digit pace in Q3 due to significant vaccination rates.
• In China, economic growth is expected to slow in the second half of 2021 from the strong pace in the first half of the year, in an environment of government regulatory crackdowns on certain sectors. But the fiscal and monetary policy stance is likely to become more supportive to protect growth.
• Price increases have remained stubbornly elevated and the debate over inflation continues. The jury is still out on whether the rise will be “transitory” or not.
• In the near-term, inflation is likely to remain under upward pressure by factors related to the pandemic shock and any unwind is likely to be gradual in an environment of strong demand growth, lean inventory positions and a normalization of service sector prices.
• On the whole, advanced economy central banks maintain their accommodative policies, however, there has been a modest tilt toward more hawkishness: The US Federal Reserve is on track to begin tapering asset purchases in November, the Norges bank became the first developed economy central bank to hike rates, and the Bank of England is telegraphing that a rate hike could come sooner than expected.
• In Emerging Markets, central banks remain divided between those hiking rates due to rising inflation (Russia, Brazil, Mexico, Peru, Pakistan. and Chile) and others supporting their economies from virus-related downside risks (India, China, and ASEAN countries).

Investment Outlook

• We are sticking with a moderate pro-risk investment strategy with economic growth likely to reaccelerate into year-end—as the economic impact of the Delta variant recedes—and global monetary policy conditions stay accommodative.
• On asset allocation, we remain overweight stocks, real estate and commodities relative to cash and fixed income. Equities and commodities should continue to perform strongly, and interest rates should rise as Delta risks recede and investors focus on the post-Delta recovery.
• Value, cyclical, and small cap stocks have faced a setback in recent months but remain attractively valued. These segments could see renewed outperformance as economic growth stays strong and risks from the Delta variant fade.
• Until the most recent turbulence sparked by China risks, US and global stocks had been experiencing a relentless rise on low volatility and very limited drawdowns this year.
• A credit event in China like an Evergrande default could spark an overdue correction in global stock markets, however, we think this would be a dip to buy given the underlying strength in the global economy and earnings and the low odds of an economic recession.
• Bond yields should rise back toward the levels seen earlier in the year as Delta variant risks peak and decline. However, rates should stay historically low, at least for now, anchored by structural trends and central bank policy.
• Within fixed income we are selective, emphasizing spread sectors such as high yield bonds over core bonds (Bloomberg Barclay’s Aggregate index) given the strength of the global recovery.
• The biggest risk to investors looking forward is that policymakers (both fiscal and monetary) stay too profligate and allow inflation to rise above what investors consider to be benign levels for too long. However, we think it is still too early to get more defensive.
• We remain bullish on the outlook for real assets, such as natural resources stocks, midstream energy/MLPs, and commodities given the strong economic growth prospects, supply side constraints and rising inflation risks.