Cautiously Optimistic

Early this year, we grappled with the onset of a once-in-a-lifetime pandemic that quickly spread across the globe and disrupted everyday life in unimaginable ways. Facing the unknown magnitude and duration of the virus, the implications for economic activity, government policy and markets were sudden and extreme.

Amidst a tumultuous investment environment, financial markets ultimately proved resilient, benefiting in no small part from unprecedented global monetary and fiscal stimulus and the rapid snap back in economic activity. All three major stock indices—the S&P 500, Russell 2000 and Nasdaq—established new all-time highs, led by the technology-heavy Nasdaq which benefitted from a less mobile, stay-at-home society.

Standing at a Crossroad Today

While 2020 was a record-breaking year for economic and market data (both negative and positive), it is important to think through the current phase of the crisis and consider the path ahead. Today, we stand at a crossroad, with many of the unknowns behind us, but fully aware that challenges remain on the path ahead. 

The pace of change and the visibility surrounding what is next is far from certain. This represents a clear break from the years heading into 2020 when market participants enjoyed a relatively high degree of stability in the economic and financial landscape. We often referred to this backdrop as “Goldilocks.” The economy was plodding along at a slow but steady pace resulting in little deviation. This led to increased visibility and certainty surrounding economic growth, corporate earnings, inflation and government policy. Although the pandemic has turned that baseline upside down and the Goldilocks economy has all but disappeared, the backdrop for markets remains, perhaps surprisingly, in a “sweet spot.”

In our view, financial markets are looking through to the end of the pandemic—the proverbial light at the end of the tunnel. And while markets have found some comfort in not one, but multiple, potential vaccines, the realities of creating these medicines in record time and distributing them to millions of people remains, at the very least, a logistical challenge. Nonetheless, we believe that investor sentiment has been positively influenced by several developments that have, on net, reduced uncertainty.

1. Resolution of the pandemic. Market consensus seems to expect the virus to be contained at some point next year. This is crucial for economies to fully reopen, companies to rehire employees and consumers to reengage in normal activities. While we are as eager as anyone to see an end to the pandemic that has wrought suffering and pain on a global scale, we feel there are numerous unknowns in how the vaccines may play out.

2. Divided government. The election results have removed uncertainty about major policy initiatives that could have developed with a Democratic sweep. We are unlikely to see wholesale changes to corporate tax policy and regulations. Further fiscal stimulus could be challenged, but markets have largely taken the November outcome in a positive light.

3. Economic recovery. Earlier this year, we alluded to the idea of turning off the economy like a light switch. With the help of monetary and fiscal policy, that switch was seemingly turned back on. Despite the sharp snapback, a loss in economic momentum and elevated levels of unemployment remain concerns.

With fewer unknowns in the market, these developments have shaped the path for recovery next year and perhaps beyond.

Step 1: Closing the Gap

With markets having set new highs as they justifiably look towards a return to normalcy in 2021, that normalcy, is quite a distance away for an economy dealing with resurgent coronavirus cases, lockdowns and vaccine timeline and distribution challenges.

The spike in cases in the US and Europe seems to have been putting downward pressure on mobility data, suggesting a potential decrease in economic activity may lie ahead. As the northern hemisphere enters winter, we expect case growth to accelerate given the southern hemisphere’s experience during its recent winter months. Rolling lockdowns until the pandemic has been largely defeated seem likely. This scenario, however, is different than this past spring when lockdowns simultaneously gripped entire nations.

The latest estimates suggest a national deployment of the vaccine could begin as early as December, with healthcare workers among the first recipients. To achieve widespread global herd immunity, approximately 10 to 15 billion doses would need to be produced, distributed and administered. It is estimated that developed economies could be fully vaccinated by the end of 2021, while emerging markets would be covered sometime in 2022. Notably, the US and many other advanced countries have already secured enough doses to vaccinate their populations.

Based on these factors, the parts of the economy hardest hit by social distancing measures (i.e., hospitality, travel and entertainment) may continue to struggle. However, we expect the broader economy to maintain its recent resiliency and swerve around the potholes ahead.

Step 2: Shifting Gears

The road to normalization will ultimately be measured in years, not months, and will take place on a global scale. We believe that there are several key themes that have emerged that will be in place long after the pandemic is in the rear-view mirror.

From a policy perspective, we expect the Federal Reserve and other central banks around the world to maintain the current low interest rate environment for years to come. As Chair Powell said earlier this year, the Fed is “not even thinking about thinking about raising rates.”¹ Not to be forgotten, more fiscal stimulus looks to be on the horizon. With a divided government, the prospects for a trimmed-down package have increased, although any relief bill would be welcomed by markets. Next year, there could be a renewed push toward true infrastructure spending, an issue that both political parties appear to support. 

Fed Policy Drives Mortgage Rates Lower

US 30-Year Home Mortgage Rate vs. US Two-Year Treasury (%)

Source: Bloomberg, as of 11/23/2020.

On the consumer front, US housing data has been a bright spot. We think this is likely to continue amid historically low mortgage rates, rising personal savings² and a gradually decreasing unemployment rate. As of November 20^th, the average 30-year mortgage dropped to 2.95%,³ a historical low. Increased housing activity may potentially lead to heightened consumer spending on household goods, especially as confidence builds around employment opportunities.

Additionally, economic activity stands to benefit from pent-up demand for services and other experiences which were effectively shuttered during the pandemic. Similarly, we believe that businesses are eager to invest in capital expenditures and rehire workers as companies gain more confidence in the prospects of the recovery.

Cautiously Optimistic in the “Sweet Spot”

There are few times in recent memory when the term “cautiously optimistic” could seem more appropriate than today. Our optimism reflects a reaccelerating growth environment following the rollout of a vaccine–the ultimate solution to the health crisis. As a result, we expect global growth to be driven by the full, unrestricted reopening of economies which may unleash pent-up demand. Further, this has the potential to be synchronized across countries and coinciding with a period of unprecedented easy global financial conditions, hence, the sweet spot.

This backdrop remains supportive of risk assets. We expect the return profile for global equities to be positive, to broaden out from “stay-at-home” winners and to outpace global bonds.

In the near term, the realities of the virus are still apparent while the global pandemic continues to take a toll on human health. We believe that markets will be volatile, and some patience is required before we reposition for a truly post-pandemic world.

1. As of 6/10/2020.
2. Source: Bureau of Economic Analysis, as of 9/30/2020. US personal savings rose 108.4% year over year for the quarter ending 9/30/2020.
3. Source: Bloomberg.