Market outlook—looking beyond the reopening

News confirming the lifting of lockdown restrictions is almost always greeted by a sense of relief and a healthy dose of optimism. It implies that consumers can resume spending, jobs can come back online, and policymakers can finally turn their attention to other pressing issues. 

viewpoints-TL-30852_Foresight-key-macro-themes-and-market-outlook-Oct-2020-hero-1040x425

Optimism aside, it’s just as important to acknowledge that the great economic reopening also brings with it a considerable sense of uncertainty. Economic data, for instance, will be extraordinarily difficult to read; forthcoming data sets are likely to be as distorted to the upside as they are to the downside as a result of lockdowns and social distancing measures introduced in the past year.

In addition, while the unprecedented disruptions and bottlenecks to global supply chains—from commodities to labor—should unwind soon (in theory), when that would actually happen remains anyone’s guess.

Crucially, as most developed economies make their way out of the COVID-19 recession, they should find themselves in the early stage of the next economic and market cycle; however, it isn’t clear whether this coming cycle will bear conventional characteristics like those we’re used to, particularly in view of how we got here in the first place.

That said, there remain important macroeconomic pillars that can be helpful to investors, in both the near term and the long term. 

1 An improving macro picture

With the reopening taking root in key developed economies, we find ourselves gravitating toward a cyclical expansion with reduced uncertainties. While the pace of the reopening will likely be uneven, in aggregate, we believe the global economy is on track to see broad improvements in general economic activity, from household spending to global trade.

It’s likely that a great deal of economic data will be distorted by year-over-year (YoY) base effects, supply chain disruptions, and the impact of stimulus measures; the likelihood of a global recession taking place over the next three years is much lower than it was in the three years leading into the pandemic. Further, uncertainties surrounding the virus itself are shrinking as vaccination efforts ramp up globally, albeit with some regional differences. 

In our view, this should allow for a gradual return to business as usual and, along with it, more traditional economic fundamentals, most of which are positive. Although this doesn’t mean we can wave goodbye to periods of risk off in the market or tell us how long this next cycle will last, it does suggest we can be generally optimistic about the economic trends in the coming years.

2 A gradual rise in interest rates, particularly at the long end of the curve

Consistent with the reopening, we expect global central banks to embark on a path toward normalization to (very) slowly unwind the extraordinary monetary policy measures introduced during the crisis. 

This will likely begin with a tapering of current asset purchases in 2021/2022—a step already taken by the Bank of Canada.¹ These policy decisions are likely to affect risk sentiment since such maneuvers typically push market-based bond yields higher both mechanically and through the expectations channel. 

We don’t, however, expect most global central banks to hike policy rates until 2023/2024 and, combined with what’s likely to be a great deal of sovereign debt issuance, we therefore expect global yield curves to steepen. 

Understandably, investors will be keeping a close eye on when the expected steepening will occur and the speed at which it happens, but we view it as a positive development as it’s emblematic of a normalizing economy. 

Opportunistic perspectives
Short-term asset allocation view (6–12 months)

TL-42982-JHIM-Opportunistic-perspectives-chart-800px

Source: Manulife Investment Management’s asset allocation team, May 10, 2021. No forecasts are guaranteed. An underweight reading indicates the potential for an asset to underperform its class or subclass on a risk-adjusted basis. An overweight reading indicates the potential for an asset to outperform its class or subclass on a risk-adjusted basis. A neutral reading indicates the potential for performance in line with the asset’s historical averages.

 

3 Sizable distortions in prices but, ultimately, limited inflationary pressures

In our base-case scenario, we expect to see some near-term inflation pressure due to base effects, supply chain disruptions, and a jump in services activity (a result of the reopening). However, we believe these price pressures will ultimately prove to be transitory as bottlenecks ease, more labor supply comes back online, and pent-up demand fades. Our longer-term inflation model suggests inflation in most developed markets may be closer to the lower end of the 2.0% to 2.5% YoY range. That said, a protracted period of elevated commodity prices and/or labor shortage would be the biggest risk to our inflation outlook.

4 A weaker U.S. dollar

Finally, we expect the U.S. dollar (USD) to weaken over our forecast horizon, driven by wider fiscal and current account deficits in the United States as well as a central bank—the U.S. Federal Reserve—that’s expected to continue to provide ample liquidity and remain dovishly positioned relative to its global peers. It goes without saying that a weaker USD will typically translate into tailwinds for a variety of asset classes, including emerging-market assets (both debt and equity) along with select developed-market equities and fixed income. 

Strategic perspectives
Long-term asset allocation view (3–5 years)

TL-42982-JHIM-Strategic-perspectives-chart-800px

Source: Manulife Investment Management’s asset allocation team, May 10, 2021. No forecasts are guaranteed. An underweight reading indicates the potential for an asset to underperform its class or subclass on a risk-adjusted basis. An overweight reading indicates the potential for an asset to outperform its class or subclass on a risk-adjusted basis. A neutral reading indicates the potential for performance in line with the asset’s historical averages.

 

The search for yield continues

Despite our belief that interest rates will gradually rise, it’s important to remember that from a historical perspective, they’re likely to remain at very low levels and will likely struggle to exceed prepandemic levels. With muted returns expected in the fixed-income space, particularly in global government debt, we believe asset classes offering higher yields to find favor with investors—particularly those that can also provide diversification benefits. 

 

 

1 "Bank of Canada will hold current level of policy rate until inflation objective is sustainably achieved, adjusts quantitative easing program," Bank of Canada, 4/21/21.