Market Outlook 2021
January 8, 2021 | Sage Capone
First Quarter 2021Key Points
- Year in Review: While 2020 was an extraordinary year, with the help of fiscal and monetary policy the global economic restart is underway.
- Economic Restart: The pandemic is an external shock to the economy and in the long run the economic shortfall will be much smaller than the global financial crisis.
- Policy Support: Both fiscal and monetary stimulus are combining to offer a range of tools to support further economic recovery.
Retirement Planning – Year in Review
In a span of 12 months, Hawaii Investors went from steady economic growth to a brutal economic contraction breaking many (negative) records in the process only to end the year with the US markets making new all-time highs and annualized GDP growth of 33.1% (7.4% in Q3 2020).
Following very strong market growth in 2019, US stocks continued to make new all-time highs in December and January on the hopes of improved trading relationships with China culminating with the S&P 500 closing at 3386 on February 19, 2020.
Shortly thereafter, COVID-19 was declared a pandemic by the World Health Organization. Although the sharp decline began on February 20, selling intensified during the first half of March, and by the end of March the Russell 2000 was down as much as 46%.
Recognizing the threat to the economy, the US Congress passed the $2.2 trillion CARES Act on March 27 and the market began its recovery. Globally, over $12.2 trillion was injected to help stabilize the world economy, including $8 Trillion from 4 of the largest central banks. [See Figure 1]
Figure 1: Central Bank Balance Sheets
In April, oil prices dropped into negative territory for the first time ever. The combination of both a demand shock and supply shock led oil futures to fall to -$37.63.
In the summer of this year, the US saw some of the most intense social unrest in decades, and in August record wildfires ravaged the US west coast.
Nonetheless, systemic fears of another Great Depression never materialized, and by September US unemployment was lower than it was expected to be by the end of 2021.
Three vaccines that are effective against the virus were announced in November clearing the way for the sectors most affected by the pandemic to slowly reopen.
For 2021, the outlook for the restart of the economy depends largely on health outcomes.
Specifically, our expectation that an effective combination of vaccine and therapeutic treatments would produce a set of conditions that should allow for removal of government restrictions on social interaction and a lessening of consumer economic hesitancy.
We believe that the pace of the economy will be a function of two factors: the immunity gap (the percentage of the population lacking immunity to the virus) as well as the reluctance gap (the reluctance of a percentage of population to engage in economic activity).
As higher portion of the population becomes immune, fewer people will be reluctant to engage in economic activity leading to a healthier overall economy.
In the short run, under more optimistic scenarios for vaccine effectiveness, much of the economic loss stemming from the pandemic could be recovered in the next year; however, a persistently large immunity gap may leave the economy with only marginal progress from current levels.
Nonetheless, in the long run, we expect the economic shortfall to be a fraction of the one endured after the Global Financial Crisis mainly because, unlike the Global Financial Crisis, the COVID-19 shock is a supply shock (akin to natural disaster).
Once the recovery effort gets underway, the supply shocks are typically followed by rapid economic restart with little overall permanent damage. The Atlanta Fed GDPNow estimate is already showing robust growth well above consensus expectations. [See Figure 2]
Figure 2: Atlanta Fed GDPNow Estimate
That does not mean that all sectors of the economy will be affected equally.
The pandemic has already altered the economic landscape by accelerating such long-term trends as the digitization and de-globalization as well as focusing attention on under-appreciated sustainability-related factors.
Ultimately, when we look beyond the effects of the pandemic, we expect the damage for consumers and labor markets to be temporary with the economy returning to the structural path of steady growth seen pre-pandemic.
Since the pandemic is still affecting the economic activity, we expect the supportive monetary and fiscal policy to remain in place in the foreseeable future. The Federal Open Market Committee “Dot Plot” reflects where members of the Committee see the interest rates that they set (Federal Funds rate).
Only one member thinks rates would be above 1% and that is not until 2023 sometime. All members think there will be no movement in 2021 from current levels. [See Figure 3]
Figure 3: The Fed “Dot Plot”
Under what is called “average inflation targeting”, the Federal Reserve has expressed the willingness to leave the interest rates lower for longer and to tolerate inflation above 2% target to make up for times when it falls below that threshold.
Under this paradigm, coming out of a recession, the Fed is unlikely to raise rates quickly, thus allowing the economy to heat up and run hot for longer.
Obviously, this stance can generate more uncertainty about the future inflation; however, most of the developed economies still continue to face deflationary pressures from aging demographics and technological innovations that are likely to balance out any emerging inflation from easy-money policies.
In addition to producing robust monetary policy response, this crisis has caused a pivot in the government’s willingness to spend aggressively on fiscal programs amid economic headwinds.
Whether this trend continues remains to be seen, but our expectation is that we are unlikely to see any austerity measures in the future with the policymakers possibly finding a compromise on additional fiscal measures around maintaining US competitiveness.
The substantial increase in public debt inevitably raises concerns about the debt’s sustainability; however, we feel that such fears are misplaced.
The consensus is that the expected nominal economic growth rate will exceed the cost of servicing the public debt over medium-term.
As always, if you would like to discuss your portfolio or re-visit your risk profile, please do not hesitate to contact us.