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October 18, 2021

Q4 2021 Outlook: Recovery Interruptus

The Delta variant managed to put a pretty good dent in the road to recovery the past few months, particularly in North America. While the pace of economic activity slowed over the summer, I expect we are on the cusp of a reaccelerated reopening trend that should carry us through the end of the year and into 2022.


Looking at U.S. GDP, the summer lull led to downgrades in overall 2021 growth expectations from the 7% range to closer to 6%. So slower, yet still robust. It’s important to note this slowdown is likely to be more of a deferral rather than lost growth. 2022 GDP growth expectations have been revised upward as pent-up spending, particularly in services like travel, get pushed out a little further. At its most recent meeting, the U.S. Federal Reserve (the Fed) revised economic projections by reducing 2021 growth to 5.9% from 7%, while boosting the 2022 forecast from 3.3% to 3.8%. To keep things in perspective, trend growth for the U.S. is roughly 2%, so even though 2022 will see a significant deceleration, it remains healthy in relation.


Delta force

In the near term, the path of COVID-19 is still the single biggest determinant for economic outcomes. While the Delta variant proved more virulent than expected—and drove a disheartening fourth-wave—it also provided conclusive evidence that vaccines do work, and assured us that we have the tools needed to protect our health care systems and society. Some authorities and individuals can, and have, made errors of judgement around vaccinations. However, at a societal level, there should be no need for further broad lockdowns if vaccine mandates are managed and enforced in a sensible manner.


We are capable of living with the virus. Therefore, the trend toward more normal functioning societies and economies should continue to unfold over the coming year. Bring on the reopening part two, unleash the pent-up spending, the recovery is not over yet.


Naturally, there remains some very real risks around COVID-19, such as new vaccine-resistant strains, the ability to vaccinate children and reduce the spread in schools, and the slowdown of the vaccine rollout in many emerging economies. The risk from vaccine deniers etc. should simply not be allowed to hold the rest of society hostage, and we increasingly appear to be heading in that direction.


Reopening interruptus

Recent market action has been consistent with what we consider a reopening pause rather than a reversal. The U.S. 10-year bond yield rallied back above 1.5% in September, after dropping to 1.2% in August from March/April’s 1.75%. In equity markets, notwithstanding a long overdue correction in the 5% range, we saw sector rotation back toward cyclicals and areas benefitting from the reopening, and away from sectors which grew during the lockdown phase. Provided COVID-19 cases continue to moderate, we expect these trends to continue into year end and are positioned accordingly.


Unprecedented uncertainty

While the reopening trend remains a key economic and market driver, it’s not the only one investors need to be aware of. The unprecedented nature of the pandemic and policy responses over the past year and a half leave economies, markets and societies buffeted by numerous crosscurrents unlike any we have seen before. Unprecedented fiscal stimulus and monetary policies—and their inevitable unwind—supply chain disruptions, inflationary pressures (and the unprecedented use of the word unprecedented!) are all coming to a head. Attempting to untangle these crosscurrents reminds us how unprecedented these times are and that there will be unexpected developments along the way. We can’t have 100% confidence in the outcomes, but we can have confidence in following a process that remains adaptable, and seeks to challenge and test our assumptions as data becomes available. While it’s always easy to predict the future, it’s devilishly difficult to get it right!


Adieu fiscal stim

In addition to peak growth rates, we are also past peak stimulus, both fiscal and monetary. The extraordinary level of policy stimulus deployed to counter the pandemic-driven recession in 2020 has been a key driver of economic and market recoveries. In the U.S., over $5 trillion was spent on COVID-19 relief packages (roughly 25% of GDP!), most of it in the form of direct transfers to households and businesses to offset income lost in the lockdowns.


As a result, while employment income plummeted, overall household income rose. Because of this, overall household savings today remain over $2 trillion above normal levels. This has significant potential to support personal consumption spending as economies continue to reopen, particularly in services areas such as travel and leisure. But while it’s great to have excess savings, the fiscal transfer programs that enabled them have ended.


But not so fast…

Although COVID-19 fiscal stimulus is ending, further stimulus has not been abandoned and there are two major spending bills working their way through the dysfunction that is Washington. The first is a roughly $1 trillion infrastructure bill that has wide bipartisan support and is likely to be approved before year end. The second is the $3.5 trillion budget proposal that is expected to be cut in half before it passes. Wrap these two bills up with the need for the U.S. to raise its debt ceiling and you have all the ingredients for significant partisan fireworks and showdowns. Base case is lots of noise, potential for some spillover into market volatility, but a high likelihood the “must pass bills” go through, as well as somewhere between $2-$3 trillion in additional fiscal stimulus. Stay tuned…


Unlike the immediate spend nature of the COVID-19 support, this spending will be spread out over a decade and include significant tax increases to offset. As a result, the actual fiscal spending stimulus will be far lower than what we saw last year. But it will provide a boost to demand, offset some of the fiscal contraction and support more economic growth in the coming years. From a political perspective, this is likely the last gasp of fiscal expansion as the 2022 midterm elections are expected to return Washington to a divided government, in which case not much will get done.


The significant contraction in fiscal stimulus is a major headwind for the coming quarters and clearly reflected in the expected deceleration of U.S. GDP. Stimulus withdrawal is coming, but it’s hard to be certain about the extent and timing. Strong job growth numbers will be needed to offset and keep household income from dipping. Given there’s several million fewer employed workers than pre-pandemic, and even more job openings, it’s reasonable we’ll see very strong jobs numbers in the months ahead.


The baton of income generation is being passed from government handouts back to private sector jobs. But we are wary of how it will unfold and will monitor for the risk of a stumble.


Adieu monetary stim

On the monetary policy front, we are also at peak stimulus and the Fed will soon begin the process of dialing back. Currently at US$120 billion per month, the Fed is expected to formally announce in November that they will start reducing the level of purchases (quantitative easing) with the goal of ending around mid 2022. So, stimulus will be dialed back, but more as a reduction than a tightening. Monetary policy remains incredibly loose and supportive with the first actual increase in interest rates not expected before 2023. This is important as bull markets often end when monetary policy tightens enough to choke off or slow economic growth. That point currently resides well into the future.


Transitory for longer

One of the biggest risks of policy tightening would be the Fed’s reaction to a rise in inflationary pressures they perceive to be sustainable. But to date, despite very strong inflation numbers, the Fed remains steadfast in considering the current inflationary pressures as transitory—in that they stem from the base effect of COVID-19 lockdowns and supply chain disruption. So long as the Fed maintains this view, markets shouldn’t fret about the volatile inflation prints we are seeing. The real risk would be if policymakers felt they had to tighten policy quicker than currently discounted. Whether the current bout of inflation proves to be transitory or structural in nature is secondary. How the Fed reacts is what will matter for markets.


For my two cents, while I believe the tail risks of both higher inflation and a return to disinflation are both greater today than we’ve seen recently, the 40-year disinflationary trend that has haunted developed economies since the 1980s remains intact (driven in large part by demographics, digital disruption and debt levels). So, while the current inflationary scare may persist a little longer, and recent spikes in energy prices may exacerbate concerns, I am not convinced that we are at the start of a new sustainably higher inflationary cycle (like 1960/70).


As we progress into and through 2022, many of the current price spikes related to supply chain shortages will likely roll over and become deflationary from a base effect perspective. Should inflation data roll over harder than predicted, the narrative could rapidly shift to a deflationary one in 2022. Severe price dislocations from supply chain challenges and logistical bottlenecks mean reported numbers are far more unreliable than usual, leaving an increased likelihood of outsized surprises in either direction. But reporting and measurement challenges are a distinct issue from how the true underlying inflationary trends ultimately evolve, they just make it harder than usual to discern those trends.


Market outlook

From a market perspective, we expect a reacceleration from the Delta slump into year end. We then see 2022 as a year of economic deceleration as the impacts of policy stimulus, both fiscal and monetary, continue to fade. Think of it as the economy exiting from COVID-19 rehab and the policy drugs are being withdrawn. By the end of 2022, the patient will have to proceed at its own pace without the artificial policy support.


In the U.S., this leaves us with an expected 2021 growth rate around 6% and 4%+ in 2022, before a more standard 2-2.5%+ in 2023. Along with slightly elevated inflation, north of 2-2.5% depending on which series one considers, it implies nominal growth rates above 9% in 2021 and 6% in 2022. That is very fertile growth to enable strong corporate earnings. While the S&P 500 Index is up roughly 16% so far in 2021, it has been driven by much stronger than expected earnings per share (EPS) growth. EPS are up almost 29%, leaving the S&P 500 Index 11% cheaper on a price/earnings (PE) basis versus the start of the year.


Just as GDP growth is expected to remain well above potential through 2023, I expect ongoing earnings growth will support further upside in equity markets. While I don’t foresee a repeat of the 15%+ returns we’ve seen recently, equity markets should still grind higher in the coming months—the S&P 500 Index has the potential to reach 5000 by the end of next year. If that occurs, returns would be roughly 11% over the next five quarters. This is slower than recent returns, but still the best potential return compared to other core asset classes, such as cash and bonds that will struggle to deliver positive returns above inflation.


I expect there will be a correction or two in the 5-10% range as healthy markets usually proceed in a two-step forward, one-step back pattern and, until recently, we have not had any significant corrections in the broad indexes. With the economic reopening cycle having room to run and a deliberately slow monetary policy withdrawal, I would see any pullbacks in markets as an opportunity to add to risk asset exposures.


Fund positioning

Within CI Global Income & Growth Fund, we’re currently positioned as follows:

  • Overweight equities with a tilt toward cyclical recovery themes
  • Underweight government bonds and short duration
  • Overweight investment-grade credit
  • Maintain an allocation to real assets
  • Sold out of our gold exposure during the quarter.


To say there are a lot of factors at play right now would be an understatement and trying to predict the exact timing and impacts is futile. That’s why we will continue to carefully monitor the economic recovery as it inevitably progresses and keep our portfolios positioned accordingly. 

About the Author

Drummond Brodeur

Drummond Brodeur, CFA

Senior Vice-President and Global Strategist
CI Global Asset Management

Drummond Brodeur, is Senior Vice-President and Global Strategist at Signature Global Asset Management. Mr. Brodeur has been in the investment industry since 1989. He has a strong background focused on China and the Pacific Basin. Prior to joining Signature in 2007, he oversaw international portfolios as Vice-President, Investments, at KBSH Capital Management Ltd. Previously, he was a senior analyst of Asian equities with the Caisse de Depot and Portfolio Manager, Asian Equities at Bankers Trust Australia. Mr. Brodeur holds a BA from the University of Western Ontario, an MA and MBA from Monash University, Melbourne, Australia, and the Chartered Financial Analyst designation.

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Published October 15, 2021