Overview
The economic rebound from last year’s deep recession is likely behind us and some of the extreme dislocations that resulted from the COVID pandemic may be moderating. While the global economy is slowing, growth remains robust, and consumers are well positioned to support the expansion. Bond yields remain unsustainably low, and we continue to prefer equities, as surging corporate profits should continue to push the bull market to new highs.
Growth moderates as global expansion progresses
The rapid spread of the delta variant is causing a rise in coronavirus infections throughout the world and challenging global economies. Global growth is moderating, though we should recognize that the economy was bound to slow following 16 months of extraordinary activity during which much of the slack resulting from last year’s recession was absorbed. Growth forecasts, for 2022, are now being dialed down, mostly because the consensus outlook implies an optimistic outcome with no room for error. Even with this slightly less cheerful view, the pace at which the global economy is expected to expand is still quite good and countries that suffered deeper recessions have the potential for an even stronger growth recovery. We forecast real GDP growth in many developed countries at close to 4% which is at least double the pre-pandemic norm.
Virus and other risks
The COVID virus remains a key risk to the global economy, especially with the delta variant being twice as contagious as its original Wuhan form and perhaps more resistant to vaccines. As a result, more stringent measures will be needed to contain the spread even as tolerance for further country lockdowns has diminished. Most governments are now turning to vaccine mandates and vaccine passports rather than forcing the lockdowns that were successful in curbing past virus waves. While it’s not yet clear how effective these new measures will be at curtailing infections, they should be less harmful to the overall global economy. Another critical risk for the global economy is the eventual shift in policy now that the economy has revived. Tremendous fiscal and monetary stimulus was delivered during the pandemic, but the need for this support is less obvious and a reversal would be a headwind for growth in 2022. One factor that could offset these risks, is that consumers have accumulated trillions of dollars in excess savings from the pandemic and can boost the economy through increased spending.
Inflation remains elevated, but may be peaking
Elevated demand and constrained supply chains have caused sharp price increases in a narrow set of goods and services that were sought after during the pandemic. Shipping costs have soared, used-car prices jumped, housing prices boomed, and computer chips have become difficult to source. On a broad basis, however, prices are now increasing at a normal rate in most areas of the economy, suggesting that the underlying trend to inflation is not out of line. Consequently, once distortions from the pandemic fade, we expect headline inflation to return to rates more in line with pre-pandemic levels. We are already starting to see some price pressures easing. For example, commodity prices are starting to ease, and shipping costs may be peaking. While we recognize a diminishing threat of too-high inflation, we do consider the possibility that inflation could run above normal levels for a few more years. Longer term, however, inflation could be lower than normal due to structural factors such as technological advancements and aging populations.
U.S. dollar wobbles within long-term downtrend
Support from a few short-term themes helped the U.S. dollar trade sideways so far this year within a tight 4% band relative to its peers. We continue to believe that the greenback remains in a longer-term downtrend and that further weakness will persist in the years ahead. The dollar’s decline should be most helpful for cyclical currencies that benefit from rising commodity prices and the global economic reopening, and we are particularly positive on currencies with central banks that will likely hike interest rates faster than the U.S. Federal Reserve.
Retailers slump on supply concerns
The S&P 500 Index declined 4.76% in September, to close at 4307.54. Retailers, in particular, were weak due primarily to a lack of inventory. While the S&P 500 finished the month in the red, this still represents almost a doubling from its March 2020 low and close to a 20% gain so far this year. The rapid increase in stocks has pushed global valuations to their most expensive reading since the late 1990s technology bubble. While the degree of overvaluation has been concentrated in U.S. equities for most of the latest bull market, many indexes outside the U.S. are now near or above fair value. At these valuation levels, profit gains will be critical to keeping the bull market alive. S&P 500 profits are on track for the most rapid recovery on record, already surpassing the pre-pandemic high, and are expected to grow at an above-average pace for the next several years. With profits having rebounded sharply, further significant growth may be more difficult to come by and we should not expect the pace of gains experienced so far this cycle to be repeated. Although valuations are elevated, we think stocks can still deliver modest returns given low interest rates, transitory inflation and sustained corporate-profit growth. We look for mid-single-digit gains in U.S. equities, with slightly better return potential elsewhere around the globe over the year ahead.
Scotsman’s Real Deal
Global economic growth has moderated but remains quite good and, in our view, the economic cycle is in its early to middle stages with several years of expansion ahead, assuming corporate profits remain intact. In the current environment, interest rates remain low, but central banks are now contemplating reductions in their bond-buying programs (reducing quantitative easing) before eventually raising interest rates. As the distortions from the COVID pandemic fade, we think that bond yields are likely to gravitate higher at a gradual pace. We would remain overweight stocks as we continue to believe stocks offer better upside return potential. The easy money has been made. We as investors, are focusing our portfolios on high quality companies, with a proven record of earnings growth, in the belief that investors will pay a premium for these stocks.