MACRO DRIVERS
The end of social distancing is approaching as economies reopen worldwide.
The United States’ economy has begun normalizing as widespread vaccine distribution has allowed for rollbacks of social distancing measures. Vaccine distribution has been progressing outside the US as well, leading to a more synchronized global expansion.
We expect the economic rebound to push annual global GDP growth in 2021 and 2022 well above historical trends.
A rapid snapback in demand is coinciding with strong inflation data in the US. However, we believe some inflation drivers, such as demand exceeding supply and logistics issues, will likely correct over time. When the economy normalizes, we expect core PCE inflation to trend in the 1.75% to 2.25% range.
Labor market improvement and moderate inflation expectations will likely result in the tapering of asset purchases and withdrawal of other ultra-accommodative monetary policies. However, we believe the US and Europe are years away from rate hikes.
In our view, the expansion is still in the early innings with room to run. The table below outlines our base case expectations for key macroeconomic indicators.
| MACROECONOMIC INDICATORS: |
BASE CASE EXPECTATIONS |
| EXPANSION (Base Case) |
|
| GLOBAL GROWTH | US leads, rest of the world catches up |
| US INFLATION | Gradually reaches Fed's 2% target |
| REACH FULL EMPLOYMENT | Late 2022 |
| FED LIFT OFF FROM ZERO | Early 2023 |
| YIELDS | Rise gradually |
| RISK APPETITE | Remains healthy |
| US DOLLAR VIEW | Trend weaker |
| Source: Loomis Sayles, as of 30 June 2021. | |
CREDIT
Tight spreads reflect a strong operating environment and fundamental outlook.
Loomis Sayles’ proprietary Corporate Health Index[1] currently indicates strong corporate health relative to history. This supports our view that the credit cycle is in expansion.
Investment grade credit spreads in the US and Europe should remain well behaved. We anticipate positive excess return potential over US Treasurys in a favorable operating environment.
We expect above-consensus economic and corporate earnings growth to help US and European high yield credit spreads compress a bit further. We believe the sector’s low duration relative to investment grade credit and higher carry will help drive return potential.
The overall US levered loan market has been highly cyclical in past cycles and should be positively correlated with the economic reopening. We remain positive on the sector but also believe security selection will be an important driver of potential outperformance.
Emerging market investment grade and high yield corporate credit spreads are currently near pre-pandemic levels. However, we see scope for tighter spreads and moderate return potential, assuming the global expansion becomes more inclusive.
In our view, the underperformance of structured products relative to corporate bonds has positioned the sector attractively on a relative basis. We see opportunity in areas of the market that that have been slower to exit the downturn, such as transportation and commercial real estate.
GOVERNMENT DEBT & POLICY
Developed market yields appear set to move higher in expansion.
Monetary policy normalization will likely take several years to achieve in the US. Federal Reserve Chair Powell may indicate tapering plans at the Jackson Hole Symposium in late August.
We believe the Fed will begin tapering asset purchases in early 2022. We expect it will deliver the first rate hike of this cycle during the first half of 2023.
We expect the consolidation in US Treasurys during the second quarter to result in a renewed uptrend in yields. The 10-year yield could reach a new year-to-date high around 1.9% by year end.
In our view, the US yield curve is likely to resume a steepening trend, with long-end yields rising modestly while the front end of the curve remains anchored.
We think the global expansion and rising inflation expectations should help drive higher yields in developed markets outside the US. We view vaccination progress and subsequent economic reopening as key catalysts.
In the past, rising US Treasury yields represented a headwind for sovereign and local-currency emerging market bonds. However, idiosyncratic country developments currently appear more likely to drive performance as the expansion broadens around the globe.
CURRENCIES
The US dollar should trend lower as the global reopening accelerates.
The global reopening has been uneven, but we believe the rest of the world will catch up to the US heading into 2022. Our outlook for improving global economic conditions and a broad expansion are consistent with a weaker trend for the US dollar.
Improving global growth expectations should support risk appetite for non-US assets and encourage a pro-risk environment.
Loomis Sayles’ foreign exchange valuation model suggests that the Australian dollar and Norwegian krone currently offer value relative to the US dollar. Within emerging markets, our model indicates Latin American currencies are currently inexpensive relative to history.
We believe country selection within emerging markets will be critical because the fundamental backdrop for each country has been progressing at a different rate. Political risk remains a key consideration and appears elevated in some emerging markets.
EQUITIES
Price-to-earnings multiples are likely to contract, but we still expect upside potential in prices.
Like many other asset classes, equity valuations currently indicate a high degree of optimism about the economic rebound and corporate earnings trajectory. Nevertheless, we believe equity indices can continue their broad advance even if driven exclusively by earnings growth.
We expect multiples to contract as underlying fundamentals catch up to the positive expectations that have been priced into equity indices.
In our view, the global equity rally is not likely to get derailed by a gradually rising interest rate environment. Underlying economic strength could drive earnings and equity markets higher even if long rates trend up.
While uneven in magnitude, the cyclical upturn across global economies has been supporting most sectors of the equity market. Traditional value-oriented sectors such as financials, materials and industrials may continue to perform well on the back of solid earnings growth.
After lagging in the first half of 2021, we believe growth-oriented sectors are likely to keep pace with value in the near term. Over the long term, we expect growth to outperform. We believe the technology sector’s secular growth story remains intact.
POTENTIAL RISKS
We think it would take an external shock or policy error to derail this expansion.
COVID-19 variants remain concerning, but the race toward vaccination should help keep new cases low and hospitalizations even lower.
We believe a return to early-pandemic-style lockdowns is unlikely for the majority of the world, which should reduce the odds of further pandemic-induced economic damage and hardship.
The world has become increasingly reliant on the internet to function. Cybersecurity attacks threaten consumers, businesses and governments. We consider large-scale hacks on national infrastructure to be a tail risk, but they have the potential to derail the broad economic expansion.
Geopolitical conflict generally represents a threat to commerce because the world is linked through global trade. A long-term supply chain disruption could erode businesses’ profit margins.
We think the tapering of asset purchases will likely be gradual and tolerated. A principal risk to our view of the cycle is if monetary policy shifts toward rate hikes too early, when inflation remains nonthreatening.
We believe the expansion and risk-on trade will continue, but remain cognizant of the risks of an external shock or policy error.
ASSET CLASS OUTLOOK
Footnotes
[1] Loomis Sayles’ Corporate Health Index “CHIN” is a proprietary framework that utilizes a combination of macro, financial market and policy variables to project US corporate health relative to history.
Disclosure
This commentary is provided for informational purposes only and should not be construed as investment advice. Any opinions or forecasts contained herein reflect the subjective judgments and assumptions of the authors only and do not necessarily reflect the views of Loomis, Sayles & Company, L.P. Investment recommendations may be inconsistent with these opinions. There is no assurance that developments will transpire as forecasted and actual results will be different. Data and analysis do not represent the actual or expected future performance of any investment product. Information, including that obtained from outside sources, is believed to be correct, but Loomis Sayles cannot guarantee its accuracy. This information is subject to change at any time without notice.
Past performance is no guarantee of future results.
Indices are unmanaged and do not incur fees. It is not possible to invest directly in an index.
Investing involves risk including possible loss of principal.
Commodity, interest and derivative trading involves substantial risk of loss.
LS Loomis | Sayles is a trademark of Loomis, Sayles & Company, L.P. registered in the US Patent and Trademark Office.
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