April 22, 2021—My three-year-old son has a Hot Wheels racetrack—one of the tracks has a portion low and flat to the ground but then takes off at a steep incline before looping and twisting and returning back toward the ground-level section of track. Where the horizontal portion of the track meets the incline is a motorized gear system that acts as an accelerator and gives the matchbox car a speed boost to stay on the track as it inclines.
This is the image I associate with today’s economy. Since the fall of 2020, we have been on the flat portion of track—kept flat and on the track, by the way, only through a combination of rapid vaccine deployment, almost $6 trillion of fiscal support, and accommodative monetary policy.
We are now going through the accelerator as the economy reopens, paving the way for $2 trillion in excess savings and over a year of pent-up demand for many services to be deployed. Economic data is taking off at a pace we haven’t observed in decades, as evidenced by recent data: U.S. initial jobless claims recorded the lowest reading since the pandemic began at 576,000; the U.S. economy created almost one million new jobs in March, and retail sales (excluding sales of autos and gas stations) clocked in for March at 15% above pre-pandemic levels.
These are encouraging signs of what we expect in the months ahead. By our estimates, U.S. GDP growth for 2021 could easily range from 6–10%, depending on how much consumers spend (versus saving or paying down debt; Figure 1). This is admittedly a very wide range and compares to Bloomberg’s median consensus estimate of 6.3%. In other words, we place good odds on the potential for an upside surprise in U.S. and global economic data.
Figure 1: Potential for upside surprise to U.S. economic activity in 2021
Three 2021 GDP projection scenarios assume different levels of fiscal stimulus is spent in 2021. All three scenarios assume that 25% of consumer savings is spent in 2021, and growth of 0% excluding savings and fiscal stimulus spent. Data as of December 31, 2020. Sources: Macrobond, Bureau of Economic Analysis, WTIA.
One area of the market that has caused some head-scratching is interest rates. Shortly before the acceleration in U.S. economic data, the 10-year Treasury yield peaked at 1.74% and has since declined by almost 20 basis points to 1.57% (Figure 2). Typically, better economic data and higher inflation coincide with higher nominal Treasury yields, so the swiftness of the market’s about-face is somewhat surprising.
We do not think there is one single explanation for the move in interest rates. The two main culprits are likely a) relative attractiveness of U.S. interest rates to foreign investors, even after accounting for costs of hedging the currency, and b) technical limits being hit as interest rates started to move down, forcing many investors on the same side of the trade (short Treasuries) to cover their short positions and buy back bonds, driving yields even lower. (This is similar to the discussion of market fragility discussed in Theme 3 of our 2021 Capital Markets Forecast.)
The reversal in rates has provided some relief to U.S. growth equities, which were getting hit as investors priced a higher discount rate into already lofty valuations. We expect the recent move in rates to represent a “digestion period,” ultimately giving way to another leg higher and steeper for the Treasury curve. Our projection is for a 10-year yield around 2–2.25% one year from now.
Figure 2: U.S. Treasury yields recede from recent highs
Data as of April 21, 2021. Source: Macrobond.
Our optimism about economic growth and expectations for higher interest rates support our recent portfolio shift into value and cyclical equities and away from growth and defensive factors. Despite some retracement of value, cyclical, and small-cap equities, we expect these parts of the equity market to resume leadership over the next 12 months. We would advise against an abandonment of growth, quality, and lower volatility; diversification is incredibly important at inflection points in the market cycle. We also acknowledge that the unprecedented nature of both the pandemic and policy response warrant a degree of humility in predicting the future.
We are optimistic in our outlook for U.S. economic growth in the months ahead, and we could see U.S. GDP growth as high as 9% in 2021. This would represent a meaningful upside surprise to consensus estimates. Though the equity market is certainly already baking in quite a bit of shared optimism, there is still room for revenue growth and operating leverage to carry equities higher over the next 12 months, and we hold an overweight position to equities versus our strategic benchmark. The ascension in interest rates looks to be taking a breather, but we expect rates too to move higher toward 2–2.25% for the 10-year Treasury. This backdrop has historically been conducive to value equities, and in March, we shifted portfolios to be better positioned for this outlook. This year the market has shown its refusal to move in a single direction for too long, so diversification and a focus on the medium term remain critical.
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