QMA 3Q 2021 Outlook
QMA shares their views on the current economic environment and outlook for 3Q 2021.
Global stocks are off to a strong start so far this year, buoyed by progress on the vaccine front and the passage of another large fiscal relief package made possible by the Democrats taking control of the US Senate by the narrowest of margins. Political uncertainty eased further with the smooth transition to the new Biden administration on January 20, despite violence at the U.S. Capitol earlier in the month during the official certification of the electoral college vote.
With the global economy on track for a robust rebound, the corporate earnings outlook for 2021 is very strong. Global earnings are expected to expand by 30%¹, and we see significant upside risks to these forecasts. Those regions/sectors that saw the steepest declines in 2020 are likely to see the sharpest profit bounceback this year. Thus, cyclical sectors like energy, industrials, and consumer discretionary likely will see explosive earnings growth after last year’s collapse. More resilient sectors, including technology, healthcare, and consumer staples, are likely to see earnings growth increase this year from 2020, but the acceleration is likely to be tame by comparison. Similarly, more cyclical-oriented regions, including emerging markets, Europe, and the UK, should lead, while the higher-quality U.S. market lags on profit growth.
More notable than the performance of the stock market at the index level has been the rotation, as last year’s losers are shaping up to be this year’s winners, consistent with the aforementioned earnings trends. Within the United States, financials and energy are up +16%¹ and +31%¹, respectively, as of March 22, while technology and healthcare are close to flat so far this year. We believe the outperformance of cyclicals and the reflation trade will continue and perhaps intensify as the year progresses since economic growth is likely to accelerate. This is especially true in the United States, where several reinforcing trends could produce the fastest growth in decades. Truly historic fiscal stimulus has produced massive excess savings for households at a time when there is already tremendous pent-up demand from a year of restrictions and lockdowns. With vaccine distribution reaching critical mass, behavioral changes towards pre-pandemic norms could unleash a torrent of spending this spring and summer.
Rising growth forecasts, building inflation pressure from very low levels, and continued policy support appear to be the key drivers of market performance. Given this potent combination, we continue to pursue a pro-risk investment strategy. On asset allocation, we are overweight stocks and commodities relative to cash and fixed income. Within equities we are pro-risk, favoring value over growth and small caps over large caps. We favor cyclical sectors over defensive and secular growth segments. Regional equity weightings are complicated by the size of the U.S. policy stimulus. As a higher-quality market, the U.S. should be expected to underperform during a strong global growth rebound, but given the size of the stimulus and the success of the vaccine rollout, the U.S. should take the baton from China as the key driver of global growth. We are currently overweight U.S. and emerging markets relative to EAFE markets within equities.
Government bond returns have been hit by rising rates. The 10-year US Treasury yield hit 1.7% on March 18, while starting the year at 0.9%, up from 2020’s low of 0.5%. TLT, the iShares 20yr+ Treasury Bond ETF, has fallen 20% from its peak in August of 2020. Given the surging growth environment, benchmark 10-year rates could hit 2.0% this year (or even 2.5% in an overshoot scenario), though upside to sovereign bond yields should remain limited by the prospect of increased central bank bond purchases or jawboning, at a minimum. However, we remain overweight fixed income risk assets, including US high yield bonds, as the pro-risk and strong-growth environment could bring spreads lower, despite spreads that are already back at pre-pandemic levels.
We believe the pandemic caused a final washout for the 12-year-long commodity bear market, which saw prices decline by more than 70%² during that period. The dramatic capitulation point was likely marked by sharply negative oil prices on the front-month futures contract in April of last year. We think commodity markets have likely entered a new up cycle driven by a number of factors: a robust post-pandemic global economic recovery, ultra-loose fiscal and monetary policies, increased inflation pressure, a lack of investment in new capacity over the past decade due to falling prices, environmental policies, and ESG investing. We expect increased financial flows to commodities as investors increasingly focus on hedging exposure to inflation risks.
Strong growth in earnings does not necessarily translate into strong equity markets. Sometimes strong earnings growth coincides with central bank tightening, which drags down equity market multiples. In 2018, for example, earnings were up 28%, but the S&P 500 was down 4% on a total-return basis as the Fed hiked rates four times that year (after hiking rates four times in 2017). But currently the Fed has assured us that it won’t hike rates until 2024 and has changed its operating playbook to allow inflation to overshoot its target. While we don’t think equity returns will keep pace with this year’s explosive earnings growth (due to already-high equity market multiples), we still think stocks will deliver above-average returns relative to long-term history.
¹Source: All growth estimates referenced are Bloomberg consensus estimates. There can be no assurance that the forecasts will be achieved. Please see additional disclosures at the end of this document
²Source: Datastream. As of 3/19/21.
For Professional Investors only. All investments involve risk, including the possible loss of capital.
Sources: Datastream, FactSet, Bloomberg, Congressional Budget Office, Consensus Economics, World Health Organization, Johns Hopkins University and QMA.
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