Economic Recovery Continues
As the Spring season advances toward Summer, we continue to see strong stock markets despite the fear of inflation and higher interest rates. The 10-year Treasury yield reached a high of 1.75% at the end of March, up from a low of about 0.50% in July 2020. Some are concerned higher interest rates may cause problems for high-growth companies and riskier equity holdings; and we don’t disagree. However, as illustrated by a steepening yield curve, the general belief is the increase in interest rates is likely caused by growing confidence in the economic recovery and should not materially interrupt the expanding economic cycle.
Although we may be fully into the economic recovery, US Gross Domestic Product (GDP) is still officially below pre-Covid/recession levels. By the end of April we will have more data, and according to Bloomberg, forecasts for GDP growth across major economies point to global growth of around 1.3% in the first three months of 2021. A mostly successful vaccine rollout, combined with additional monetary and policy stimulus and an easing of lockdowns led the International Monetary Fund (IMF) to increase the global growth forecast to 6%, and the US forecast to 6.4% for 2021; the fastest in nearly 50 years.
Positioning Investment Assets
In 2019, we made material changes to investment allocation when we adjusted to more defensive positioning for what we believed to be the later stages of the economic cycle. As mentioned earlier this year, as the government lockdowns were relaxed in 2020, we believe the economy saw the lows of this economic cycle. Today the ongoing trends of economic reports continue to support this logic. As such, we are continuing our “Tactical Pivot”, reducing defensive holdings and adding to both market index and tactical exposures. In summary, positioning assets for the upcoming stages of our new economic cycle.
For a multitude of reasons, cash on the sidelines is at an all-time high. In our view, this may imply market participants are underestimating the near-term prospects for economic expansion resulting from pent up demand and a successful vaccination effort. As such, we believe earnings estimates and price targets for stocks may be revised higher over the coming quarters; events that have historically proven to be some of the strongest catalysts for pushing stock prices higher.
Consistent with this theme, we believe there are potentially attractive tactical opportunities. Throughout Q1 2021, where appropriate, we have added back exposure to both high yield bonds and energy stocks we had removed in 2019. Overall, we have increased exposure to Environmental, Social and Governance (ESG) investments as well as foreign stocks. In addition, we have added tactical exposure to the healthcare sector and have shifted the focus for some of our alternative investment allocation from defensive positioning to opportunistic “event driven” (mergers, spinoffs, restructuring, etc) holdings.
Inflation has begun to increase over the last few months and while it is possible inflation could get out of control, our base case is more muted. Referring to the IMF and their outlook for 6% global growth in 2021, their growth projection moderates to 4.4% in 2022. Focusing on the US, the projections from the March 2021 meeting of the Federal Reserve, show GDP moderating from 6.5% in 2021 down to 2.2% in 2023.
We have positioned investment assets for the combination of Fed’s easy monetary policy (low rates) and the Biden administrations expansive fiscal policy (spending); both of which we believe will lead to higher bond yields and a steeper yield curve. Eventually, we believe increases in economic strength (inflation) will cause the Fed, and likely central banks around the world, to increase interest rates.
In addition to inflation, populations around the world are receiving Covid vaccinations. Variants in the virus could slow the benefits of vaccination and the race to herd immunity. Should new variants become resistant to current vaccines, or should current vaccines have material widespread side effects (blot clots), it would likely slow the rapid expansion currently taking place.
Markets also seem to have excess optimism and so far, are taking the noise in stride. Speculation through meme trades like Gamestop usually doesn’t end well for those investors who have no idea how stocks are valued. To take advantage of ‘cheap money’, many companies are raising capital through traditional IPO’s, nontraditional direct listings, and SPAC offerings. Some may turn out to be successful, however it is likely more than a few will eventually implode. While these stories lead in the media, they generally don’t lead to a more consistent rate of return.
We will continue to provide ongoing updates on our views and investment positioning. Should you have specific questions about our strategy, please let us know and we will make sure to review details at our next meeting. And while we don’t recommend fixating on short term market fluctuations, if you would like to check specific investment performance across all your accounts, our Buttonwood Portal is available 24/7. Or you can contact us, and we will provide reports specific to your questions and financial life.
Thank you for your continued trust and allowing us to serve as your Family CFO!