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2021 GLOBAL MARKET
OUTLOOK

Q4 Update: Growing pains

The COVID-19 delta variant, inflation and central bank tapering are unnerving
investors. We expect the pandemic-recovery trade to resume as inflation
subsides, infection rates decline and tapering turns out to not equal
tightening. The outlook favors equities over bonds, the value factor over the
growth factor and non-U.S. over U.S. stocks.

Full Report
Executive Summary
Executive Summary


Navigation to...
Introduction Cycle still in recovery phase Two key indicators Reopening trade
still makes sense Regional snapshots Asset-class preferences

INTRODUCTION


2021 GLOBAL MARKET OUTLOOK –
Q4 UPDATE: GROWING PAINS

The post-lockdown recovery has transitioned from energetic youthfulness to
awkward adolescence. It’s still growing, although at a slower pace, and there
are worries about what happens next, particularly about monetary policy and the
outlook for inflation. The inflation spike has been larger than expected, but we
still think it is transitory, caused by base effects from when the U.S. consumer
price index (CPI) fell during the lockdown last year and by temporary supply
bottlenecks. Inflation may remain high over the remainder of 2021 but should
decline in early 2022. This means that even though the U.S. Federal Reserve
(Fed) is likely to begin tapering back on asset purchases before the end of the
year, rate hikes are unlikely before the second half of 2023.

Another worry is the highly contagious COVID-19 delta variant. The evidence so
far is that vaccines are effective in preventing serious COVID-19 infections.
Vaccination rates are accelerating globally, and emerging economies are catching
up with developed markets. Infection rates appear to have peaked globally in
early September. This means the reopening of economies should continue over the
remainder of 2021. The onset of winter in the northern hemisphere will be a
test, but the rollout of booster vaccination shots should help prevent widescale
renewed lockdowns.

The conclusions from our cycle, value and sentiment (CVS) investment
decision-making process are broadly unchanged from our previous quarterly
report. Global equities remain expensive, with the very expensive U.S. market
offsetting better value elsewhere. Sentiment is slightly overbought, but not
close to dangerous levels of euphoria. The strong cycle delivers a preference
for equities over bonds for at least the next 12 months, despite expensive
valuations. It also reinforces our preference for the value equity factor over
the growth factor and for non-U.S. equities to outperform the U.S. market. 



Andrew Pease

GLOBAL HEAD OF INVESTMENT STRATEGY

"The strong cycle delivers a preference for equities over bonds for at least the
next 12 months, despite expensive valuations."

- Andrew Pease


STATUS OF ECONOMIC RECOVERY

Cycle still in recovery phase

The post-lockdown recovery has been powerful, and most developed economies have
seen double-digit gross domestic product (GDP) rebounds from 2020 lows. Even so,
we think the cycle is still in the recovery phase, although it is maturing.
Despite strong growth, there is plenty of spare capacity. This can be seen in
the employment-to-population ratio for prime-age workers in the United States.
The chart below shows the ratio has recovered from the pandemic lows, but only
to levels reached during the relatively mild recessions in the early 1990s and
2000s. We expect the U.S. labor-market recovery should still resemble a typical
post-recession recovery over the next few quarters.



U.S. employment-population ratio for prime-age workers



The U.S. recovery, however, is more advanced than that of other developed
economies. The following chart shows how far GDP has recovered, relative to the
pre-COVID-19 peak in 2019. GDP is 0.8% higher in the U.S., although this level
is still short relative to the pre-COVID-19 trend. GDP is 2.5% below 2019 levels
in the euro area and 4.5% below in the United Kingdom. We expect more cyclical
upside for economic growth outside the U.S., and this should allow market
leadership to rotate toward the rest of the world. 



GDP in Q2 2021 relative to pre-COVID-19 peak in 2019




INFLATION FORECAST AND WAGE OUTLOOK

Two key indicators

Last quarter, we listed two indicators that should offer a guide to the Fed’s
expected reaction to the inflation spike.

The first is five-year/five-year breakeven inflation expectations, based on the
pricing of Treasury Inflation Protected Securities (TIPS). This is the market’s
forecast for average inflation over five years in five years’ time. It tells us
that investors expect inflation will average 2.17% in the five years from late
2026 to late 2031. The TIPS yields are based on the CPI, while the Fed targets
inflation as measured by the personal consumption expenditure (PCE) deflator.
The two move together over time, but CPI inflation is generally around 0.25%
higher than PCE inflation. A breakeven rate of 2.75% would suggest the market
sees PCE inflation above 2.5% in five years’ time. Market inflation expectations
are currently comfortably below the Fed’s worry point.



Watchpoint indicator #1: U.S. 5-year/5-year breakeven inflation rate



The second indicator is the Atlanta Fed’s Wage Growth Tracker, and this has a
less-comforting message about inflation risks. It reached 3.9% in August, which
is close to the 4% threshold where we judge that the Fed will become concerned
about the inflationary impact on the growth of wages. A breakdown shows that the
spike has been mostly driven by wages for low-skilled, young people in the
leisure and hospitality industry. This suggests the surge has been caused by
temporary labor supply shortages and that wage pressures should subside as
economic activity normalizes. This indicator, however, will be an important
watchpoint over the next few months. 



Watchpoint indicator #2: Atlanta Fed Wage Growth Tracker



 

"Market inflation expectations are currently comfortably below the Fed’s worry
point."

- Andrew Pease




OUTLOOK FOR STOCKS: GROWTH VS. VALUE

Reopening trade still makes sense

The reopening trade, which lifts long-term interest rates and favors cyclical
and value stocks over technology and growth stocks, worked well for several
months following the vaccine announcement last November. Value outperformed
growth and yield curves steepened. The trade has reversed in recent months,
however, amid fears that the delta variant might derail the economic recovery.
The impact has been magnified by short covering in bond markets as investors,
who have been short or underweight, have been forced by the rally to buy back
into the market, pushing bond yields even lower.

The reopening trade should resume in coming months. The cyclical stocks that
comprise the value factor are reporting stronger earnings upgrades than
technology-heavy growth stocks, and the value factor is cheap compared to the
growth factor. Financial stocks comprise the largest sector in the MSCI World
Value Index, and they should benefit from further yield-curve steepening, which
boosts the profitability of banks. Long-term interest rates should rise as
global growth remains above trend, delta-variant fears fade, the short squeeze
unwinds and central banks begin tapering back on bond purchases.

The rotation in economic growth leadership away from the United States should
also help the reopening trade. The rest of the world is overweight cyclical
value stocks relative to the U.S., which has a higher weight to technology
stocks.

Emerging market (EM) equities have been poor performers since the vaccine
announcement, but there are some encouraging signs. Initially, they were held
back by the exposure to technology stocks in the MSCI Emerging Markets Index and
the slow rollout of COVID-19 vaccines. More recently, they have come under
pressure from the slowdown in the Chinese economy and the regulatory crackdown
on Chinese tech companies. The vaccine rollout across emerging markets has
accelerated and policy easing in China should soon improve the growth outlook.
The path of Chinese regulation is harder to predict, but it is now largely
priced in, with Chinese technology companies underperforming their global peers
by nearly 50% from February 2021 through mid-September.

The resumption of the reopening trade should also result in U.S. dollar
weakness. The U.S. Dollar Index (DXY) has traded sideways since the vaccine
announcement. It should weaken once investors have confidence that delta-variant
risks are subsiding and realize that the Fed is likely to remain dovish as
inflation risks decline. The dollar typically gains during global downturns and
declines in the recovery phase. Dollar weakness should support the performance
of non-U.S. markets, particularly emerging markets.




RISKS: VARIANTS, INFLATION, CHINA WEAKNESS

The key risk is that the delta variant or similar proves resilient to
vaccination or that infection rates escalate during the Northern Hemisphere
winter. The evidence so far is that vaccinations are highly effective in
preventing serious illness. In Israel, booster shots appear to have slowed the
rate of new cases.

Another watchpoint is inflation and the response of central banks. Our
expectation is that this year’s inflation spike is mostly transitory and that
the major central banks, led by the Fed, are still two years from raising
interest rates.

Finally, there is the risk of a sharper-than-expected slowdown in China. Credit
growth has slowed this year and the purchasing managers’ indexes (PMI) have
trended lower. Monetary and fiscal policy have been eased, however, and senior
officials have signaled that more stimulus is on the way. China policy direction
and credit trends will be an important watchpoint over coming months.


 

"We expect the inflation spike is mostly transitory and that the major central
banks, led by the Fed, are still two years from raising interest rates."

- Andrew Pease




MARKET AND ECONOMIC OUTLOOK BY REGION

Regional snapshots


UNITED STATES

The U.S. economy is likely to sustain above-trend growth into 2022. However, the
easiest gains appear in the rear-view mirror at the end of the third quarter as
the recovery phase of the business cycle matures. This is most visible for
corporate earnings, where S&P 500® Index earnings-per-share already sit 20%
above their previous cyclical high.

Strong fundamentals have helped power the stock market to new highs. Early
evidence that the delta-variant wave may be fading and the potential for greater
vaccine access for children are positives for a more complete recovery in the
quarters ahead. The Fed looks poised to start tapering its asset
purchases around the end of 2021. The timing of the first rate hike will then
hinge on what happens to inflation next year. Our models suggest that inflation
is likely to drop back below the Fed’s 2% target in 2022. If that is correct,
the Fed is likely to remain on hold into the second half of 2023.

Wage inflation is a key risk to this view. It is running unusually strong for
this stage of the cycle, and record hiring intentions from businesses could
exhaust spare capacity in the year ahead. We expect the 10-year U.S. Treasury
yield to rise moderately from 1.37% in mid-September to 1.75% in coming months.

Fiscal stimulus negotiations continue to grab headlines in Washington, D.C. The
tax provisions in these bills are likely to be the most impactful for financial
markets. We estimate that higher corporate taxes could subtract about four
percentage points from S&P 500 earnings growth in 2022. This could create
volatility and opportunity in markets. Given our strong cyclical outlook, our
bias continues to be a risk-on preference for equities over bonds for the
medium-term.




EUROZONE

Euro area growth slowed through the third quarter but looks on track for a
return to above-trend growth over the fourth quarter and into 2022. Vaccination
rates are high, and the euro area has more catch-up potential than other major
economies, particularly the United States. The euro area is also set to receive
more fiscal support than other regions, with the European Union’s pandemic
recovery fund only just starting to disburse stimulus, which will provide
significant support in southern Europe. Polls in advance of Germany’s federal
election on Sept. 26 suggested the electorate was moving toward the political
left, which means the new government is likely to support expansionary fiscal
policy and a continued dovish stance by the European Central Bank (ECB).

The MSCI EMU Index, which reflects the European Economic and Monetary Union, has
performed broadly in line with the S&P 500 so far in 2021. We think it has
potential to outperform in coming quarters. Europe’s exposure to financials and
cyclically sensitive sectors such as industrials, materials and energy, and its
relatively small exposure to technology, gives it the potential to outperform as
delta-variant fears subside, economic activity picks up and yield curves in
Europe steepen.




UNITED KINGDOM

As of mid-year, UK GDP was still nearly 4.5% below its pre-pandemic peak. We see
plenty of scope for strong catch-up growth as borders are fully reopened and
activity normalizes. Supply bottlenecks and labor shortages have triggered a
sharp rise in underlying inflation and created concerns that the Bank of England
(BoE) may start rate hikes in the first half of 2022. We think the BoE is
unlikely to be that aggressive. We expect inflation to decline in early 2022 as
supply constraints ease, which should convince the BoE to delay rate hikes.

The FTSE 100 Index is the cheapest of the major developed equity markets in late
2021, and this should help it reflect higher returns than other markets over the
next decade. Around 70% of UK corporate earnings come from offshore, so one
near-term risk is that further strengthening of British sterling dampens
earnings growth. The other risks are mostly around policy missteps, for example,
early tightening by the Bank of England.




JAPAN

The Japanese economy is expected to get a shot in the arm as rising vaccination
rates improve mobility and reduce the risk of further lockdowns, and as
political leadership changes result in more fiscal stimulus: the Japanese
election is due to be held before Nov. 28. Japanese equities look slightly more
expensive than other regions such as the UK and Europe. We maintain our view
that the Bank of Japan will significantly lag other central banks in normalizing
policy.




CHINA

We expect Chinese economic growth to be robust over the next 12 months,
supported by a post-lockdown jump in consumer spending and incremental fiscal
and monetary easing. Despite a big improvement in vaccination rates, COVID-19
outbreaks remain a risk given the Chinese government’s zero-tolerance approach.
The major consumer technology companies have seen significant drops in stock
prices recently due to more aggressive regulation. Some uncertainty remains
around the path of future regulation, especially as it relates to technology
companies, and as a result we expect investors will remain cautious on Chinese
equities in the coming months. The property market, particularly property
developers as recently highlighted by Evergrande’s debt crisis, remains a risk
that we are monitoring closely.




CANADA

Canada leads the G71 countries in terms of the vaccination rollout, which should
minimize the risk of large-scale lockdowns over winter. The delta variant has
taken an economic toll, however, with industry consensus projections now
predicting 5% GDP growth in 2021 versus estimates of more than 6% just three
months ago. Even so, growth remains above-trend and the odds of additional
fiscal expenditures to support the economy have increased. This means that
weaker growth due to COVID-19 is unlikely to change the Bank of Canada's (BoC)
tightening bias.

Tapering of asset purchases should be complete by the end of the first quarter
of 2022. BoC Governor Tiff Macklem has indicated that the reinvestment phase of
the bonds held by the central bank will commence once quantitative easing has
ended. This should generate an estimated C$1 billion in weekly bond purchases,
down from the current pace of C$2 billion. The BoC will likely only consider
shrinking its balance sheet after it has started lifting interest rates. The BoC
projects that the output gap will close sometime over the second half of 2022,
and that rate hikes will be considered after economic slack has disappeared. We
believe that the timeline may be a tad aggressive, and a delay to 2023 for
liftoff is more likely. This would better align the Canadian central bank with
its American counterpart.




AUSTRALIA/NEW ZEALAND

The Australian economy is set to return to life, with lockdowns likely to be
eased in October and November. Consumer and business balance sheets continue to
look healthy, which should facilitate a strong recovery. The reopening of the
international border in 2022 will provide a further boost. Fiscal policy has
supported the economy through the downturn, and there is potential for further
stimulus in the lead-up to the federal election, which is due before the end of
2022. The Reserve Bank of Australia has begun the process of tapering its
bond-purchase program, but we expect that a rise in the cash rate is unlikely
until at least the second half of 2023.

New Zealand’s most recent lockdown will drag on Q3 GDP, but similar to
Australia, we expect a solid rebound as the economy reopens. The government aims
to provide a vaccine to all adults by the end of 2021, after which borders will
gradually reopen. This will provide a boost, particularly to tourism-exposed
sectors. Despite having recently put off hiking interest rates due to the recent
lockdown, we expect the Reserve Bank of New Zealand will start raising rates
this year. Even though they have significantly underperformed global equities
this year, New Zealand equities still screen as relatively expensive compared to
other regions.


 

"Our models for the U.S. suggest that inflation is likely to drop back below the
Fed’s 2% target in 2022. If that is correct, the Fed is likely to remain on hold
into the second half of 2023."

- Andrew Pease




VIEWS ON EQUITIES, BONDS AND CURRENCIES

Asset-class preferences

Our cycle, value and sentiment investment decision-making process in late
September 2021 has a moderately positive medium-term view on global equities.
Value is expensive across most markets except for UK equities, which are near
fair value. The cycle is risk-asset supportive for the medium-term. The major
economies still have spare capacity and inflation pressures appear transitory,
caused by COVID-19-related supply shortages. Rate hikes by the U.S. Fed seem
unlikely before the second half of 2023. Sentiment, after reaching overbought
levels earlier in the year, has returned to more neutral levels.



Composite Contrarian Indicator: Sentiment shifts toward neutral



 * We prefer non-U.S. equities to U.S. equities. Stronger economic growth and
   steeper yield curves after the third-quarter slowdown should favor
   undervalued cyclical value stocks over expensive technology and growth
   stocks. Relative to the U.S., the rest of the world is overweight cyclical
   value stocks.
 * Emerging markets equities have been relatively poor performers this year, but
   there are some encouraging signs. The vaccine rollout across EM has
   accelerated and policy easing in China should soon boost the economic growth
   outlook. China’s regulatory crackdown has caused significant underperformance
   by Chinese technology companies, but this should be less of a headwind going
   forward now that it is priced in.
 * High yield and investment grade credit are expensive on a spread basis but
   have support from a positive cycle view that accommodates corporate profit
   growth and keeps default rates low. U.S. dollar-denominated emerging markets
   debt is close to fair value in spread terms and will gain support on U.S.
   dollar weakness.
 * Government bonds are expensive, and yields should come under upward pressure
   as output gaps close and central banks look to taper back asset purchases. We
   expect the 10-year U.S. Treasury yield to rise toward 1.75% in coming months.
 * Real assets: Real Estate Investment Trusts (REITS) have significantly
   outperformed Global Listed Infrastructure (GLI) so far this year, to the
   extent that REITS are now expensive relative to GLI. Both should benefit from
   the pandemic recovery, but GLI has some catch-up potential. GLI should
   benefit from the global re-opening boosting domestic and international
   travel. Commodities have been the best-performing asset class this year amid
   strong demand and supply bottlenecks. The gains have been led by industrial
   metals and energy. The pace of increase should ease as supply issues are
   resolved, but commodities should retain support from above-trend global
   demand.
 * The U.S. dollar has been supported this year by expectations for early Fed
   tightening and U.S. economic growth leadership. It should weaken as global
   growth leadership rotates away from the U.S. and toward Europe and other
   developed economies. The dollar typically gains during global downturns and
   declines in the recovery phase. The main beneficiary is likely to be the
   euro, which is still undervalued. We also believe British sterling and the
   economically sensitive commodity currencies—the Australian dollar, the New
   Zealand dollar and the Canadian dollar—can make further gains, although these
   currencies are not undervalued from a longer-term perspective.



Asset performance since the beginning of 2021



 

"Stronger economic growth and steeper yield curves after the third-quarter
slowdown should favor undervalued cyclical value stocks over expensive
technology and growth stocks."

- Andrew Pease



1 The Group of Seven is an inter-governmental political forum consisting of
Canada, France, Germany, Italy, Japan, the United Kingdom and the United States.




PRIOR ISSUES OF THE GLOBAL MARKET OUTLOOK

Q3 2021 update

Q2 2021 update

Annual 2021 update

Q4 2020 update

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IMPORTANT INFORMATION

The views in this Global Market Outlook report are subject to change at any time
based upon market or other conditions and are current as of September 27, 2021.
While all material is deemed to be reliable, accuracy and completeness cannot be
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Please remember that all investments carry some level of risk, including the
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2021 Global Market Outlook – Q4 update
UNI-11911




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