TRANSAMERICA 2021 MID-YEAR MARKET OUTLOOK - Not insured by FDIC or any federal government agency. May lose value. Not a deposit of or guaranteed ...
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TRANSAMERICA 2021
MID-YEAR MARKET OUTLOOK
1
Not insured by FDIC or any federal government agency. May lose value. Not a deposit
of or guaranteed by any bank, bank affiliate, or credit union.
WHERE WE STAND | 2021 MID-YEAR MARKET OUTLOOK
ABOUT THE AUTHOR
Tom is the Chief Investment
Officer of Transamerica Asset
Management, the mutual fund
arm of Transamerica.
Tom has more than 30 years of investment
management experience and has managed large
mutual fund portfolios and separate accounts.
As a member of the senior management team,
Tom heads Transamerica’s thought leadership
efforts and provides perspectives to advisors, clients,
the media, and general public. He writes and publishes
Transamerica’s Market Outlook and other relevant
commentary. He also heads Transamerica’s mutual
fund sub-adviser selection and monitoring process,
as well as product management. Tom holds a
bachelor’s degree in political science from Tulane
University, and an MBA in finance from the Wharton
School at the University of Pennsylvania.
THOMAS R. WALD, CFA®
Chief Investment Officer,
Transamerica Asset Management, Inc.
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WHERE WE STAND | WHERE WE STAND: 2H 2021
WHERE WE STAND: 2H 2021
MARKET ENVIRONMENT
• Although stock prices have reached record highs and credit spreads are now below pre-pandemic levels,
a new series of market concerns have emerged for investors. These include the risks of rising inflation,
federal tax increases, higher interest rates, stock valuations, and a potentially looming market correction.
While investors should pay close attention to each one, we believe the trade-off between them and higher
economic and earnings growth still favor the markets moving higher.
COVID-19
• The successful distribution of vaccines is now showing up in dramatically declining COVID-19 case trends
and strongly improving recovery rates. While there is still much ground remaining to eradicate the virus,
these rapidly improving results should provide a strong boost for the economy and add further confidence
to the markets.
U.S. ECONOMY
• We see the U.S. economy accelerating impressively in the year ahead and believe calendar year (CY) 2021
gross domestic product (GDP) growth could exceed 7%. Such economic growth is likely to be driven by
increasing vaccine distribution, falling COVID-19 case trends, national business re-openings, and continuing
fiscal and monetary stimulus — all of which should result in large, pent-up consumer demand being unleashed
as the year progresses. This is likely to result in an official V-shape recovery by year-end and an expansionary
environment as 2022 begins.
U.S. STOCKS
• We believe U.S. stocks continue to be well positioned for gains in the year ahead as corporate earnings
growth for CY 2021 should be substantial and meaningfully eclipse pre-pandemic record levels. The shift
in leadership from growth to value stocks is likely to continue in our judgment and could be indicative of
further market strength. Our year-end 2021 price target on the S&P 500® is 4,600 and our one-year target
is 4,800. While there is risk of a short-term market correction, we would likely view such an event as a
buying opportunity.
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WHERE WE STAND | WHERE WE STAND: 2H 2021
INTEREST RATES AND FED POLICY
• We believe the Federal Reserve will not begin tapering its monthly open market large-scale asset purchases
until 2022 and will maintain the fed funds rate at its current target range of 0–0.25% into 2023, therefore
continuing market-friendly monetary policy throughout the year ahead. While inflation remains somewhat
of a wild card, we believe the Fed will be thorough and deliberate in determining its impact on policy.
The yield curve will likely steepen further, with the 10-year Treasury rate challenging or modestly
exceeding 2% by year-end.
CREDIT AND INCOME
• While fundamentals continue to improve since last year’s crisis, credit spreads for high-yield and
investment-grade bonds are now at multiyear lows, creating a highly challenging environment for
income-seeking investors. Against this backdrop, a potential wave of high-yield rating upgrades in the year
ahead could potentially provide excess returns for those capable of identifying them. We believe a diversified
mix of several nontraditional, income-oriented asset classes can provide for more competitive yields with
lower overall interest rate risk.
INTERNATIONAL STOCKS
• While increasing COVID-19 vaccine distribution will be vital in the year ahead and investor patience may be
required at times, we believe opportunities in both international developed and emerging markets are likely
given a stronger than expected global economic recovery. As global economic growth rates reverse from last
year’s contraction, central banks are likely to remain highly accommodative, making the case for international
stocks stronger than it has been in recent years. Spiking COVID-19 cases, particularly in India, present the
highest risk to this scenario.
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WHERE WE STAND | MARKET CATALYSTS AND CONCERNS
MARKET CATALYSTS AND CONCERNS
One of the great challenges of investing is that once a given set of market
concerns is reconciled, apparently setting up a course for clear sailing,
new concerns can quickly emerge, often driven by the very resolution of
those worries before them.
At this time a year ago, peak investment concerns pertaining to the COVID-19 pandemic
were passing, though nobody was truly convinced that was the case, nor could they have
been. Virus case numbers and fatalities were cresting for a brutal and tragic second wave,
and the U.S. economy had just concluded its worst single quarter of contraction since the
Great Depression. Stocks had recently sold off at speeds never seen before, and credit
spreads across the bond markets had more than tripled. Congress and the Federal Reserve
were both in their early phases of historically unprecedented fiscal and monetary stimulus,
and the ultimate success of those trillions being put to work was still considered to be very
much in question. While vaccines had begun clinical trials, there was no hard data available
to support their efficacy.
Since that time, a flying wedge of favorable developments have knocked most of those
economic and market concerns out of the game. Amazingly efficacious vaccines now seem
to have COVID-19 on the run, and as the economy prepares to reopen further in the months
ahead, the pent-up demand of consumers and businesses looks ready to take the economy
to new heights and from a state of recovery to one of expansion. Corporate earnings appear
primed to also break through pre-virus records. More than $5 trillion in fiscal stimulus has or
is currently filtering through the system, and while the Fed now has some degree of inflation
and taper timing to wrestle with, it still looks as though zero short-term rates will be with us for
at least another year and probably longer. In anticipation of all this, stock prices have reached
record highs and credit spreads have narrowed to pre-pandemic levels.
The resolutions of last year’s concerns have now become this year’s catalysts for the markets
to keep moving higher. Yet as this plays out, a new set of market concerns enter, created
by those very resolutions to all that besieged the markets during last year’s darkest hours.
These new concerns include the threat of rising inflation, higher long-term interest rates,
potentially higher federal taxes, fears of overvalued stock prices and the risk of a meaningful
short-term market correction. They may not carry the weight of a global pandemic in its early
stages or a calendar quarter of economic contraction rivaling the worst of Herbert Hoover’s
administration, but they are nonetheless still a force to deal with.
The investor’s challenge as we look out to the 2H 2021 and beyond is to recognize the extent
of these freshly minted concerns and net them out against the dramatic improvement we have
seen in the economy and asset prices over the past year. Then we can determine whether the
current favorable trend can continue in this new environment.
We believe it can and likely will, though patience and tolerance of volatility may be needed
along the way.
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WHERE WE STAND | MARKET ENVIRONMENT
MARKET ENVIRONMENT
Although stock prices have reached record highs and credit spreads are
now below pre-pandemic levels, a new series of market concerns have
emerged for investors. These include the risks of rising inflation, federal tax
increases, higher interest rates, stock valuations, and a potentially looming
market correction. While investors should pay close attention to all of these,
we believe the trade-off between them and higher economic and earnings
growth still favors the markets moving higher.
Many are currently asking what could reverse the trend of rising equity prices and declining
risk premiums in the bond markets or, at the very least, create a pause in the action.
There are no shortages of answers being offered to this question as, in our judgment,
a changing environment has set in since the year began and it is one with a new group of
investor concerns.
We have always believed markets climb a “Wall of Worry,” and following one of history’s
most successful climbs, one wall is for the most part behind us, yet another has been quickly
constructed. If this new wall is scaled in the year ahead, there is a strong probability, in our
opinion, markets will continue to move higher, though we suspect there could be a fair amount
of volatility along the way.
INFLATION RISES FROM THE ASHES
After a long absence, inflation fears have reemerged from the abyss and are now front and
center in the mix of economic concerns potentially threatening the harmonious combination
of economic growth and accommodative monetary policy.
The concept of rising inflation following a decade of benign and, at times, stagnant consumer
price increases probably should not be all that surprising to investors. Nonetheless, recent
numbers more than speak loudly on this risk. We have now seen year-over-year inflation rates
not witnessed in decades, as exhibited first by the April consumer price index (CPI) report
displaying a headline year-over-year reading of 4.2%, its highest since 2008, and a core CPI
(ex. food and energy) annual rise of 3%, its highest since 1996. On a monthly basis core CPI
increased 0.9%, its highest rate since 1981. This was followed by readings on the Federal
Reserve’s preferred measure of inflation, the personal consumption expenditures (PCE) price
index, which rose 3.6% on its headline report and 3.1% for core PCE, confirming inflation had
returned at least temporarily.
The May CPI report displayed further rising inflation as the headline number posted a monthly
rate of 0.5%, and core at 0.7%. On a year-over-year basis, headline CPI reached 5% its highest
annual increase since August 2008, and core CPI rose 3.8% for its highest reading since
June 1992.
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WHERE WE STAND | MARKET ENVIRONMENT
While these numbers certainly sound concerning at first blush, we believe there are
unique circumstances to be considered.
First, much of the April and May increases and the anticipated rise in inflation in the year ahead is likely resulting
from base effects, meaning annual comparisons are being made versus the depths of last year’s economic
contraction when monthly inflation rates were among the lowest ever recorded (April and May 2020 in
particular). These difficult inflationary comparisons are likely to continue throughout the remainder of the year.
It is also important to note that should GDP meet current expectations of about 7% growth for 2021, this would
put the cumulative increase of aggregate GDP at better than 12% in a year and a half’s time. Obviously, this rate
of growth is not sustainable longer term, but while it is in effect, inflation is almost certain to pick up, particularly
as supplier bottlenecks develop against the backdrop of a reopening global economy.
Inflation Rises from the Ashes
Monthly Year-Over-Year CPI since April 2020
5.0%
4.2%
2.6%
1.7%
1.3% 1.4% 1.4% 1.4%
1.2% 1.2%
1.0%
0.6%
0.1%
0.3%
4/20 5/20 6/20 7/20 8/20 9/20 10/20 11/20 12/20 1/21 2/21 3/21 4/21 5/21
Source: Bloomberg
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WHERE WE STAND | MARKET ENVIRONMENT
The second is that given the torrid pace of economic growth expected over the upcoming
three quarters or so, no one should really be shocked to see inflation rise considerably
above its previous average of approximately 1.5% over the past decade as measured by both
the CPI and the PCE. These benign and, at times, suppressed inflation trends (such as sub
1% during the 2014-2015 time frame) of the past 10 years were at least in part a result of
changing age demographics in the workplace, larger globalization of supply chains, and the
continuing expansion of technology-based distribution channels. Clearly, these trends are
not disappearing anytime soon, however for the next several months or so they may become
overshadowed by a rapid pace of growth driven by the end of a global pandemic and
a corresponding record economic recovery.
Recent Inflation History
Calendar Year CPI 2013 - 2020
2.3%
2.1% 2.1%
1.9%
1.5%
1.4%
0.8% 0.7%
2013 2014 2015 2016 2017 2018 2019 2020
Source: Bloomberg
Third, the larger question at hand is whether the current rise in inflation is transitory in nature,
as the Federal Reserve has stated it believes it likely will be, or if it will be more permanent,
perhaps triggering a turn in the longer-term cycle. We are prone to agree with the transitory
perspective — that the increase over the upcoming months, even if it were to tangibly surpass
the Fed’s long-term target of 2% for a few or even several months, would probably still be
mostly accountable to the historically anomalous growth rate of the post-pandemic recovery
and the base effects created by last year’s suppressed inflation rates. Under this scenario, once
growth normalizes to a longer-term trend and year-over-year comparisons are less extreme,
structural factors previously present in the economy could then once again drive inflation back
down toward the Fed’s 2% target by the early months of 2022.
Finally, we believe it is also important to consider inflation in a longer-term context. Over the
past 50 years, the CPI’s average annual rate of increase has been 3.9%, with a median annual
rate of 3.0%. This equates to half a century of inflation averaging more than twice that of the
past decade, including a couple of stints in the mid-1970s and early 1980s of double-digit
consumer price increases. Yet over this past half century, U.S. GDP has averaged real growth of
better than 2.7%, and the S&P 500 has averaged an annualized total return of just below 11%.
Hence, there is clearly tolerance for higher short-term inflation within longer-term economic
and market cycles.
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WHERE WE STAND | MARKET ENVIRONMENT
Long-Term Inflation
Consumer Price Index (CPI) 1971 - 2021
16%
14%
12%
10% CPI % Y/Y
Average 3.9% Y/Y
8%
Median 3.0% Y/Y
6%
4%
2%
0%
-2%
-4%
‘71 ‘73 ‘75 ‘77 ‘79 ‘81 ‘83 ‘85 ‘87 ‘89 ‘91 ‘93 ‘95 ‘97 ‘99 ‘01 ‘03 ‘05 ‘07 ‘09 ‘11 ‘13 ‘15 ‘17 ‘19 ‘21
Source: Bloomberg
HIGHER TAXES COULD ALSO POSE RISK TO GROWTH
As the Biden administration plans for additional fiscal and infrastructure spending, these
pending legislative efforts could be linked to federal tax increases as a means of funding.
Such proposed tax hikes are likely to coincide, at least to some degree, with what was originally
communicated by the Biden campaign before the election.
To pay for additional spending packages, such as the American Jobs Plan and the American
Families Plan, proposed legislation from here on will likely include attempts to meaningfully
alter the present federal tax code. This could include increases to the marginal corporate tax
rate, a minimum tax on corporate book income, an increase to the top bracket individual rate,
additional payroll taxes for employers and highly paid employees, a shift in the maximum capital
gains rate to that of the individual rate, and the elimination of step-up in basis treatment on
inherited assets. In whole or in part, these provisions are nothing to sneeze at.
The American Jobs Plan had been initially proposed by the White House at $2.3 trillion, though
counterproposals from both sides seem to be inferring a negotiating range of $1 trillion–$1.7
trillion. The Democrats’ proposal uses funding from federal tax increases focusing on raising
the marginal corporate tax rate from 21% to 28%, a 15% minimum tax on book income for
certain companies, and an increase on foreign income to 21%. These provisions and rates are
of course subject to negotiation.
The American Families Plan has been proposed at $1.8 trillion in spending, though pending
negotiations are also likely to impact that number. This is expected to be funded through a
series of tax hikes on individuals believed to include raising the top individual bracket from 37%
to 39.6%, eliminating the step-up basis pertaining to capital gains on inherited assets above
$1 million, adding a 3.8% Medicare tax on incomes above $400,000, and, perhaps receiving the
most attention of late, increasing the maximum capital gains rate from 24% to 43% for those
with annual incomes above $1 million. The last of these raised a few eyebrows the final week of
May when President Biden’s budget plan was submitted with retroactive treatment of this new
capital gains rate beginning in April.
.
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WHERE WE STAND | MARKET ENVIRONMENT
At the current time, initial versions of these bills are expected to encompass close to $3 trillion in additional
spending, with these federal tax hikes expected to fund the great majority of them. Coincidentally, the Tax
Foundation has estimated the impact of the Biden tax increases, as communicated by his campaign prior to last
year’s election, to be very close to this amount over the upcoming decade.
Potential Federal Tax Increases
Current vs. Proposed
50% Step-Up in Cost Basis on Inherited Assets
45% Current Proposed
39.6% 40% Step-Up In Basis Permitted End effects of Step-Up In
Basis for gains of $1 million
35%
39.6% or more
43.4%
30%
37.0%
25%
28.0%
20%
23.8% Minimum Corporate Tax on Book Income
15% 21.0%
Current Proposed
10%
No minimum tax 15% minimum tax on corporate
5%
book income for companies
0% with net income above $2B
Top Capital Gains Marginal Top
vidual ($1 million+) Corporate Rate Individual
sed Rate Top Current Rate Top Proposed Rate
ehouse.gov) Source: Made In America Tax Plan (treasury.gov), American Families Plan (whitehouse.gov)
Republicans are adamantly opposed to raising taxes in the form of any of the proposed provisions and have taken
the tack of seeking unused portions of the previously approved legislation as funding for a smaller spending
package. Therefore, these potential tax increases are in all probability headed for a major showdown in Congress
with some fierce party lines being drawn. With Vice President Harris’ tie-breaking vote in the Senate, both a looming
risk and dependency for the two parties, the stakes will likely be escalating in the months ahead.
On June 24, President Biden announced support for a bipartisan agreement on an infrastructure deal for
approximately $1.2 trillion, however we would caution ultimate passage could still be very much in question and
require agreement from progressive Democrats. Furthermore, passage of a bipartisan agreement would not
preclude Democrats from continuing to seek larger infrastructure legislation through the budget reconciliation
process and potentially including close to a full menu of new tax provisions as separate legislation.
In the event these tax provisions were to be passed in their entirety and as initially proposed, there could be some
negative impact to economic growth, perhaps in the neighborhood of 1%–2% in annual GDP growth. This of course
would have to be netted out against all other factors favorably influencing the economic recovery and expansion.
As the proposed capital gains tax increase has received much attention of late, we believe it is important to note
that approximately 75% of U.S. stock ownership is held in 401(k) and other tax-deferred retirement accounts not
subject to this tax treatment.
The political battle over higher taxes will probably be a major story line for the markets in the months ahead,
and in the event even a good portion of them are passed, we believe the impact to economic growth should prove
manageable amid the improving economic environment. But there is clearly a lot more to follow on this front.
10WHERE WE STAND | MARKET ENVIRONMENT
THE ECONOMY AND THE MARKETS WILL NEED TO ADJUST TO HIGHER
LONG-TERM INTEREST RATES
Long-term interest rates have experienced a fast and furious rise as shown in the 10-year U.S.
Treasury yield, which increased from its record closing low of just 0.52% on August 4, 2020,
to 1.74% on March 31, 2021. We believe this reflected a dramatic rise in expected economic
growth during this time as well as the risk of higher inflation, if at least on a transient basis.
Since April however, yields have retreated with the 10-year Treasury rate closing on June 18
at 1.44%.
Rising Long-Term Interest Rates
10-Year U.S. Treasury Yield July 2020 – June 2021
3/31/21
1.74%
1.75%
1.50%
6/11/21
1.47%
1.25%
1.00%
7/1/20
0.75% 0.68%
0.50%
8/4/20
0.52%
0.25%
7/20 8/20 9/20 10/20 11/20 12/20 1/21 2/21 3/21 4/21 5/21 6/21
Source: Bloomberg
The recent decline in longer-term yields since April perhaps represents the bond market’s
view that inflation will prove to be transitory and/or further fiscal spending legislation will
either be passed at lower price tags or potentially not at all. Nonetheless, we continue to see
7%-type GDP growth for CY 2021 and still above trend 3%–4% expansion in 2022. For this
reason alone, we feel longer-term rates will resume an upward path.
We would not be surprised to see the 10-year yield challenge or perhaps modestly exceed
2% between now and year-end. We would not, however, view those higher levels as necessarily
a risk to the economy or the equity markets in and of themselves. Even at a 2% yield on the
10-year Treasury, longer-term rates would remain low by historical standards, as over the past
30 years this rate has averaged north of 5%.
11WHERE WE STAND | MARKET ENVIRONMENT
Long-Term Look at Long-Term Rates
10-Year U.S. Treasury Yield Since 1981
16%
14%
12%
10-Year U.S. Treasury Yield
10%
Average 5.561%
8%
6%
4%
2%
0%
‘81 ‘83 ‘85 ‘87 ‘89 ‘91 ‘93 ‘95 ‘97 ‘99 ‘01 ‘03 ‘05 ‘07 ‘09 ‘11 ‘13 ‘15 ‘17 ‘19 ‘21
Source: Bloomberg
In the event the 10-year U.S. Treasury Yield does rise to 2% in the months ahead, it will be the
first time it has reached that mark since July of 2019. However, it is important to note, at that
point in time the yield curve was inverted as the three-month Treasury rate was yielding higher
than the 10-year rate. As of June 18, the yield curve is far differently positioned with a positive
slope of 1.40%, which before this past April had not been seen since 1Q 2017. A steep yield
curve can be interpreted as a bullish forecast of economic growth and a favorable environment
for banks and other lending institutions.
The higher long-term rates we are now experiencing and the volatility of those rates, in our
judgment, are indicators of stronger economic growth and should be viewed in consideration
with rising stock earnings, so their overall impacts to the economy and the markets should,
in our judgment, be netted out with these factors in mind.
Tale of Two Yield Curves
Three-month — 10-Year Treasury Yield Curves, July 2019 vs. June 2021
2.25%
2.07% 2.02%
July 2019
2.00%
Slope of Curve = -0.05%
1.75%
1.45%
1.50%
1.25%
1.00%
June 2021
0.75%
Slope of Curve = +1.43%
6/11/21
0.50%
7/31/19
0.25%
0.02%
0.00%
3M 6M 1Y 2Y 3Y 5Y 7Y 10Y
Source: Bloomberg
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All indexes are unmanaged and cannot be invested into directly. Past performance does not guarantee future results.WHERE WE STAND | MARKET ENVIRONMENT
CORRECTION RISK FOR STOCKS IS RISING
We are not going to argue with the premise that the risk of a short-term pullback in the equity markets of about
10% or so, off the most recent record levels, is high at this point in time. We believe it is. We say this not based
on market fundamentals or valuations but more on human nature and history.
Human nature dictates investors will take profits at some point, and, as of June 18, the S&P 500 has posted a
total return of better than 90% since late March of last year. So practically speaking, most investors are probably
unlikely to feel foolish booking some of those gains.
Correction Risk Looms
S&P Total Return Since March 2020
100%
93.70%
90%
80%
70%
60%
50%
40%
30%
20%
10%
0%
3/23/20
4/23/20
5/26/20
6/25/20
7/28/20
8/27/20
9/29/20
10/29/20
12/1/20
1/4/21
2/4/21
3/9/21
4/9/21
5/11/21
6/11/21
Source: Bloomberg
History also serves as a guide that a correction could be on the horizon. Since 1950, the S&P 500 has had 36
corrections of more than 10%, translating to an average of about once every two years. Moreover, the average
time between the end of these corrections and the beginning of new ones has been about 18 months and the
median time approximately one year.
In looking at index price gains between those corrections, there have been only four occasions since 1950 when
the S&P rose more than 100% without experiencing a correction. Those occurred during 1984–1987, 1990–1997,
2003–2007, and 2011–2015. At better than a 90% move on the S&P 500 since March of last year, the argument
can certainly be made we are getting long in the tooth. On the flip side, the S&P did rise more than 300%
between July 1990 and October 1997 before it sold off in the double digits. So a correction is not necessarily a
foregone conclusion in the next year, though history infers the likelihood is increasing.
13WHERE WE STAND | MARKET ENVIRONMENT
Stock Corrections Since 1950
Standard & Poor’s 500
Declines greater than 10% = 36
Annualized Total Return = 11.60%
4500
4000
Correction
3500
Bear Market
3000 S&P 500
2500
2000
1500
1000
500
0
50 52 54 56 58 60 62 64 66 68 70 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10 12 14 16 18 20
Source: Bloomberg
With that said, a few points are important for context. First, if we do see a 10% or greater
pullback in this environment, in our judgment, there is a strong probability it will prove to be a
buying opportunity given the current market environment of stronger than previously expected
economic and corporate earnings growth, combined with what we believe to be still market
friendly monetary policy from the Fed.
Second, we believe corrections and double-digit pullbacks in the market are simply part of
long-term investing and should not be overemphasized. They are perhaps best viewed as
opportunities for investors to realign portfolio allocations or rebalance into stocks at more
favorable prices.
Finally, to put all of this in more personal terms, there was a 14% correction in the S&P 500
concluding five days after yours truly was born in 1960. Since that day, the S&P 500 has
averaged better than a 10.5% annualized total return, inclusive of another 29 corrections
along the way. Unfortunately, I know this from stock charts only.
14WHERE WE STAND | MARKET ENVIRONMENT
Stock Corrections Since 1960
Standard & Poor’s 500
Declines greater than 10% = 29
Annualized Total Return = 10.70%
4500
4000
Correction
3500
Bear Market
3000 S&P 500
2500
2000
1500
1000
500
0
60 62 64 66 68 70 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10 12 14 16 18 20
Source: Bloomberg, https://awealthofcommonsense.com
Perhaps that sums it up best. A correction is likely in the next several months, however
those investing for the long haul probably should not sweat it too much.
PRICE-EARNINGS MULTIPLES ON STOCKS ARE HISTORICALLY HIGH,
BUT THERE IS MORE TO THE STORY
In a seemingly paradoxical statement, we assert that price-earnings ratios on stocks are
historically high, but valuations are not. Feel free to read that sentence again.
We make this argument based on the premise that price-earnings multiples should not be
assessed in isolation and without regard to the longer-term interest rate environment. We
believe stocks should be judged in terms of the expected excess returns they are offering
versus longer-term rates (U.S. Treasury bonds). Those expected excess returns then need to
be judged in terms of their own risk profile, or what we commonly refer to as the Equity Risk
Premium (ERP) comparison.
With multiples of about 24x trailing 12-month earnings (Q320–Q221 FactSet Earnings Insight,
June 17) and 21x forward 12-month earnings estimates (Q321–Q222 FactSet) on the S&P 500,
many are quick to utilize well-known adjectives such as “stretched,” “frothy,” or “overdone” to
characterize current stock valuations. Within the strict confines of comparing current
multiples to those of past cycles, those descriptors might appear accurate, but when flipping
the perspective to one of earnings yields in comparison to still historically low long-term
interest rates (10-year Treasury yield), we see the broader equity market as being in the
range of reasonably to attractively valued.
15WHERE WE STAND | MARKET ENVIRONMENT
Stock Valuations
Equity Risk Premium (ERP)
40%
Subsequent 3 Year Annualized Return
FactSet CY 2021 S&P 500
Earnings Estimate = 189.99 30% 6/11/21 ERP: 3.02%
6/11/21 20%
S&P 500 Forward Earnings Yield 4.47%
minus 10-Year U.S. Treasury Yield 1.45%
Equity Risk Premium 3.02% 10%
Forward earnings yield calculated as
calendar year 2021 expected 0%
EPS/current index value.
-10%
-20%
-3% -2% -1% -0% 1% 2% 3% 4% 5% 6% 7% 8%
Source: Bloomberg, FactSet Equity Risk Premium
INVESTORS MAY BE BEST SERVED TO WELCOME THE WALL
While it may sound a bit counterintuitive, investors may actually want the markets to have
ongoing concerns at any given time. Perhaps it is when there are no evident concerns that they
should be most worried.
In the current environment, it seems to be a question of trade-offs. The economy is looking at
dramatically higher growth than was believed to be the case just months ago. Fiscal stimulus
is filtering through the economy in far higher dollar amounts than believed to be the case when
the year began. Corporate earnings are also breaking through to record levels, and we believe
there is a strong probability the Fed will maintain a close to zero short-term interest
rate environment into 2023.
The corresponding trade-offs with these improving conditions involve higher longer-term
interest rates that are still quite low by historical standards and a potential rise of inflation that,
in our opinion, is likely to prove transient in nature. The tax drama will need to play out and as
for correction risk, suffice it to say that has always been part of the deal for long-term investors.
So the trade-off is higher growth for some of the side effects, for lack of a better term, of that
higher growth. That is a deal probably all investors would have taken a year ago and one they
should strongly consider still taking now.
16WHERE WE STAND | MARKET ENVIRONMENT
WHERE WE STAND: MARKET ENVIRONMENT
• A new set of market concerns have descended upon investors through 1H 2021, however we believe they net
out as a fair trade-off given stronger than previously expected economic and corporate earnings growth.
• Inflation is emerging as the top concern for investors, though we believe there is a high probability it will
prove to be transitory in nature and return close to 2% trend as 2022 begins.
• A political drama awaits on higher federal taxes through a number of potentially changing provisions mostly
linked to pending infrastructure and spending legislation. However, if passed, such provisions are likely to
have a manageable impact given expected economic and corporate earnings growth in the year ahead.
• Long-term interest rates have moved higher, however even with a continued move on the 10-year Treasury
yield to 2%, these rates would remain low by historical standards, hence their ultimate effect on the economy
and markets would have to be netted out against the stronger economic growth contributing to their rise.
• While price-earnings multiples on stocks may appear high, we believe the broader equity market is
still reasonably to attractively valued based on a comparison of expected earnings yields to longer-term
interest rates.
• The probability of a short-term correction in stocks is running high, however we believe a widespread market
sell-off under the current environment would likely prove to be a buying opportunity.
.
17WHERE WE STAND | COVID-19
COVID-19
The successful distribution of vaccines is now showing up in dramatically
declining COVID-19 case trends and strongly improving recovery rates.
While there is still much ground remaining to eradicate the virus, these
rapidly improving results should provide a strong boost for the economy
and add further confidence to the markets.
From the very beginning of the pandemic, we have said COVID-19, and its social and economic
consequences, was at its roots a medical crisis, ultimately requiring a medical solution.
Even as last year’s economic shock turned toward recovery, it was apparent that everything
being done to fight through the depths of contraction and depressed markets — from the
trillions in monetary and fiscal economic stimulus to the sacrifices so many took on in terms of
business shutdowns and social distancing restrictions — was simply a bridge to a real solution
for the virus.
VACCINES TO THE RESCUE
As we look ahead to 2H 2021 and beyond, that solution appears to be in the process of
becoming reality and seemingly within grasp by year-end. We are in this position, one that few
may have thought possible at this time last year, thanks to the brilliant minds of medicine and
science who developed highly efficacious vaccines capable of national distribution in short
time frames and amid great pressure.
No question, this has been a remarkable medical accomplishment, one that ranks as perhaps
the greatest ever. It is also one the markets identified early and accurately, thus greatly
enhancing their strong upward moves in recent months.
By all measures, the combined distribution of the three vaccines, Pfizer, Moderna, and Johnson
& Johnson, has dramatically exceeded even the highest of expectations from just months ago.
According to Our World in Data, as of the start of June 11, over 142 million Americans had been
fully vaccinated, including more than 50% of the adult U.S. population, and 172 million have
now received at least one dose representing more than 65% of all adults. These vaccination
rates have accomplished a considerably faster pace than expected just months ago.
ACTIVE CASES DOWN AND RECOVERY RATES UP
This exceptional rate of vaccinations is now showing up in materially improving virus statistics
versus those seeming so dire and distressing when 2021 began. As recently as the first week
of January, infections surpassed a daily count of 300,000 with single-day fatalities horrifyingly
reaching more than 4,000. As of June 18, the seven-day averages on both metrics had declined
to less than 14,000 and 400 respectively. Obviously, there is much more work to be done to
reduce these numbers to where they belong at zero, however the overall trends are
certainly encouraging.
18WHERE WE STAND | COVID-19
Beginning in early February and dovetailing with the ramp up of vaccine distribution, two of
the most critical statistics, in our opinion, also began to reverse themselves and are now
displaying favorable trends:
Active cases have declined considerably. Defined as people currently diagnosed with the
virus and seeking recovery, this metric has seen a material decline since the vaccine ramp up.
Peaking at more than 9.1 million in the U.S. during the last week in January, this number has
fallen to 5.1 million, representing a 40% decline from its January peak (Worldometer, June 13,
2021). Of course, 5.1 million is still far too many people to be fighting COVID-19, however the
reduction of this aggregate number and its reversal in trend serves as strong evidence of the
vaccines’ positive impact.
COVID-19 in United States
Active Cases Declining
12,000,000
10,000,000
8,000,000
6,000,000
4,000,000
2,000,000
U.S. Active Cases
0
4/20
5/20
6/20
7/20
8/20
9/20
10/20
11/20
12/20
1/21
2/21
3/21
4/21
5/21
6/21
Source: Worldometers.info
Recovery rates have risen to their highest level to date. This number represents those who
have fully recovered from the virus as a percentage of total cases since the pandemic began.
This ratio, of course, started out low at the pandemic’s outset but continuously increased
as infections slowed following last year’s lockdowns, reaching 65% in late October 2020.
However, as the fierce second wave of the virus spread throughout 4Q 2020, total recoveries
fell to 58% of all cases by mid-December. Yet since that time and with the help of the vaccines,
total recoveries as of June 18 have reached 83%, their highest point to date. Some believe a
total recovery rate of 90% could prove to be strong indication herd immunity is not far away.
19WHERE WE STAND | COVID-19
COVID-19 in United States
Recovery Rates Rising
90%
82%
80%
70%
60%
50%
40%
30%
20%
10%
Recoveries / Total Cases
0%
4/20
5/20
6/20
7/20
8/20
9/20
10/20
11/20
12/20
1/21
2/21
3/21
4/21
5/21
6/21
Source: Worldometers.info
GOOD MEDICINE FOR THE ECONOMY
Favorable downstream impacts of these improving virus trends are now being seen in key economic indicators
as well as the actions of public officials, further allowing for business reopenings and the loosening of
social distancing requirements. The Center for Disease Control and Prevention in mid-May updated its
recommendations to include that people fully vaccinated no longer need to wear masks or physically distance
in any setting, except where required by law. These developments have led to speculation we could see a fully
open economy by the fall.
All of which bodes very well for consumer and business confidence and the activity of those anticipating the
results thereof. Pent-up demand is in the queue, aggregate consumer savings are higher in dollar terms than ever
before, and while markets are the great anticipators of future events, it is unlikely, in our opinion, all or even most
of the accelerating economic recovery/soon-to-become expansion has been fully discounted in asset prices.
WHERE WE STAND: COVID-19
• Stronger than expected distribution of vaccines during 1H 2021 has resulted in dramatically improving U.S.
COVID-19 case and recovery trends.
• Active cases of the virus have declined more than 40% since their peak levels in January, providing strong
support to reopen businesses and public venues.
• Recovery rates now exceed 80% of all documented cases and could soon reach levels associated
with herd immunity.
• All of this in our opinion bodes extremely well for the economy and the markets as pent-up consumer
demand could soon be unleashed, and we do not believe this is yet fully discounted in most asset prices.
20WHERE WE STAND | U.S. ECONOMY
U.S. ECONOMY
We see the U.S. economy accelerating impressively in the year ahead and
believe CY 2021 GDP growth could exceed 7%. Such economic growth is
likely to be driven by increasing vaccine distribution, falling COVID-19
case trends, national business reopenings, and continuing fiscal and
monetary stimulus — all of which should result in large consumer pent-up
demand being unleashed as the year progresses. This is likely to result in
an official V-shape recovery by year-end and an expansionary environment
as 2022 begins.
Perhaps the biggest story for investors through the first half of 2021 has been the dramatic
upgrade of U.S. economic growth expectations versus when the year began. Back in January,
most forecasts were calling for about 4% GDP growth in CY 2021, with 1Q only slightly
positive. The storyline back then was one of continuously rising virus cases impacting the
first half of the year, followed by a vaccine ramp up some time in the summer months, back
weighting economic growth for a strong pick up during the third and fourth quarters.
Since that time, the strong vaccines roll out has moved up the light and shortened the
tunnel. In addition, the $1.9 trillion American Rescue Plan (also known as the COVID-19
Relief and Stimulus Package of 2021) passed by Congress in March exceeded fiscal spending
expectations, based largely on the tie-breaking vote of Vice President Kamala Harris in the
Senate, a political reality absent before the Georgia Senate runoff elections the first week of
the year.
We are now likely looking at a faster and more widespread reopening of the economy
combined with over $5 trillion of fiscal stimulus, passed since the pandemic’s onset, still
filtering through the system. In addition, there appears to be large pent-up demand stemming
from a consumer base now holding trillions more dollars in aggregate savings than was the
case a year ago. When you throw in a still friendly Federal Reserve, we could very well be
looking at an economic formula tantamount to a racehorse at the gates.
21WHERE WE STAND | U.S. ECONOMY
V IS THE WINNING SHAPE OF RECOVERY
Following last year’s severe contraction in 1H 2020, a great deal of speculation ensued as to
the shape of the pending economic recovery with various letters of the alphabet bantered
about. It now appears as though that debate will soon be settled with the formal conclusion
of a V-shaped recovery by year-end.
V-Shaped Economic Recovery
Likely to see Record U.S. Aggregate GDP by Year-End 2021
$19.5T
$19.3T
$19.0T $19.1T
$18.8T
$18.6T
$17.3T
4Q 19 1Q 20 2Q 20 3Q 20 4Q 20 1Q 21 2Q 21*
* Federal Reserve Bank of Atlanta GDPNOW Forecast
Source: Bureau of Economic Analysis, Federal Reserve Bank of Atlanta
From our perspective, there is a high probability the strong 1Q 2021 trajectory of better than
6% annualized GDP growth will continue to accelerate into the second half of the year. Driven
by rising percentages of those vaccinated, business reopenings, fiscal stimulus, and consumer
spending, annualized GDP growth, we believe, will perhaps challenge or surpass double digits
in 2Q21 and potentially exceed 7% for CY 2021.
Under such a scenario, real aggregate GDP (inflation adjusted) will eclipse its pre-virus record
level achieved in CY 2019 sometime in 2H 2021. This would complete a full recovery from the
depths of last year within about a year and a half’s time, meeting the widely accepted criteria
of a V-shape and therefore, in our judgment, transitioning the cycle of economic growth from
recovery to expansionary mode.
A major factor driving this trend, in our opinion, is the expectation of pent-up demand in the
economy as businesses and public venues reopen and the overall population moves closer to
pre-virus consumer activity. Pent-up demand is commonly defined as a backlog of suppressed
consumer activity unleashed into the economy when a recovery emerges, or in the case of our
current environment, when businesses reopen and social distancing restraints are lifted. It is
likely pent-up demand in the present environment will far exceed those seen in previous post-
recession economic recoveries since the end of World War II. As a result, the economy is likely
to experience its strongest single year of annualized growth since at least 1984 and perhaps a
good bit further back than that, as in before the days of Elvis Presley.
22WHERE WE STAND | U.S. ECONOMY
Pent Up Demand Accumulates
Household Savings Rise During Pandemic to Multi-Decade High
35%
30%
Pent Up Demand
25%
Household Savings Rate
20%
15% 14.9%
10%
6.7%
5%
0%
96 98 00 02 04 06 08 10 12 14 16 18 20 21
Source: Bloomberg
The potential impact of pent-up demand driving economic growth higher over the next three quarters is likely
best embodied in the estimated $3.5 trillion of additional personal savings across the U.S. population versus a
year ago (Bank of America estimate). This build up in savings is the result of a variety of factors, including the
payments many have received from the fiscal stimulus programs like the CARES Act and American Rescue Plan,
as well as the more than 14 million people who have been able to return to work since the depths of March and
April 2020, when more than 22 million jobs were lost in those two months. In addition, most people have spent
considerably less money while working from home and sheltering in place over the past year plus.
Employment Recovery
Monthly Job Gains Since May 2020
+4.9MM
+2.8MM
+1.7MM +1.6MM
+716k +680k +785k
+536k +559k
+264k +233k +278k
-306k
5/20 6/20 7/20 8/20 9/20 10/20 11/20 12/20 1/21 2/21 3/21 4/21 5/21
Source: Bloomberg
23WHERE WE STAND | U.S. ECONOMY
Obviously, this year’s potentially better than 7% annualized rate of economic growth
is unlikely to continue into 2022, however given existing activity, we could still see
above-trend growth in the 3%–4% range for 2022, though there are numerous variables
capable of impacting the trajectory between now and next year. Nonetheless, the U.S.
economy now appears primed to make up for all the lost ground from the lost year of 2020
and likely a good bit more.
U.S. GDP Growth for 2021
Likely to be Highest Since 1984 or 1951
9.0%
8.0%
7.0%
6.0%
5.0%
4.0%
3.0%
2.0%
1.0%
0.0%
-1.0%
-2.0%
-3.0%
-4.0%
‘51 ‘53 ‘55 ‘57 ‘59 ‘61 ‘63 ‘65 ‘67 ‘69 ‘71 ‘73 ‘75 ‘77 ‘79 ‘81 ‘83 ‘85 ‘87 ‘89 ‘91 ‘93 ‘95 ‘97 ‘99 ‘01 ‘03 ‘05 ‘07‘09 ‘11 ‘13 ‘15 ‘17 ‘19 ‘21
Calendar Year Real GDP % 2021 Estimate 8% 2021 Estimate 7%
Source: Bloomberg
FISCAL AND MONETARY STIMULUS IMPACT CONTINUES
There is no question in our opinion that the massive amount of both fiscal and monetary
stimulus coming from Congress and the Federal Reserve has played a major role in the
economic and market recoveries over the past year. So far, this combined stimulus has
tallied approximately $8.6 trillion coming from both corners, equating to about 40% of
annual aggregate GDP.
On the fiscal side, Congress has passed more than $5 trillion in stimulus packages since
the pandemic began. This has consisted of the $2.2 trillion CARES Act signed into law
during March of 2020, $900 billion in stimulus from the Consolidated Appropriations Act
in December of 2020, and $1.9 trillion from the American Rescue Plan (also known as the
COVID-19 Relief and Stimulus Package) passed in March of 2021. These numbers do not
include an additional $4 trillion or so expected to be proposed by the White House later this
year in the potential combined amounts on the table for the American Jobs Plan and American
Families Plan, likely headed for the House of Representatives in the upcoming months.
24WHERE WE STAND | U.S. ECONOMY
Fiscal Stimulus Has Come Up Big
Enacted and Proposed Packages Total $9 Trillion
$6.0 Enacted Fiscal Stimulus $6.0
Proposed Fiscal Stimulus
$5 Trillion
$5.0 $5.0
$4.1 Trillion
American Rescue
$4.0 $1.9 Plan Act of 2021 $4.0
Trillions ($)
Trillions ($)
American
$1.8
$3.0 Consolidated $3.0 Families Plan
$0.9 Appropriations
Act, 2021
$2.0 $2.0
American
$2.2 CARES Act $2.3 Jobs Plan
$1.0 $1.0
$0.0 $0.0
Source: Made In America Tax Plan (treasury.gov), American Families Plan (whitehouse.gov), H.R. 1319 (Congress.gov), Consolidated Appropriations Act, 2021
(Congress.gov), Coronavirus Aid, Relief and Economic Security Act (Congress.gov)
In terms of monetary stimulus, the Fed last year took the fed funds rate down to a target range of 0–0.25%,
and with that reinstituted monthly open market large-scale asset purchases of $120 billion. While the Fed
will likely begin reducing this monthly pace of asset purchases, perhaps ultimately down to zero by 2023, this
monetary stimulus will likely reverberate for some time after its completion. These open market bond purchases
have taken the Fed’s balance sheet up from about $4.3 trillion when the pandemic began to about $7.9 trillion
as of the end of May 2021. These purchases are on pace to add another $840 billion by year-end, putting the
combined amount of fiscal and monetary stimulus since the pandemic began at about $9.5 trillion. Should the
American Jobs Plan and American Families Plan be passed at currently proposed levels, this would put total
monetary and fiscal stimulus in the $13 trillion range since March of 2020.
25WHERE WE STAND | U.S. ECONOMY
Monetary Policy Remains Market Friendly
Fed Funds Rate and Fed Balance Sheet
2.75% 8.5
Trillions
2.50% 8.0
2.25% 7.5
2.00%
7.0
1.75%
6.5
1.50%
6.0
1.25%
5.5
1.00%
5.0
0.75%
0.50% 4.5
0.25% 4.0
0.00% 3.5
3/19 6/19 9/19 12/19 3/20 6/20 9/20 12/20 3/21 6/21
Fed Funds Target Rate (%, LH) Federal Reserve Balance Sheet ($T, RH)
Source: Bloomberg
This fiscal and monetary stimulus has provided two very different catalysts for the economy
and the markets. The fiscal stimulus has been and continues to be a tailwind for the economy.
It will likely prove additive to economic growth as payments to individuals and families and
financial assistance to businesses and local governments filter through the system.
The monetary stimulus, both in terms of the zero lower bound on the fed funds rate and the
large-scale open market asset purchases, has, in our judgment, greatly enhanced consumer
confidence and market liquidity. The markets also continue to have confidence, in our opinion,
the Fed will maintain the current fed funds target of 0–0.25% probably into 2023 and hold
open market bond purchases at the current monthly level of $120 billion into 2022. While this
timeline has recently come into high focus and debate, it still appears clear that a zero lower
bound on the fed funds rate and material amounts of Fed open market activity will be with us
for at least a couple more World Series and Super Bowls.
Hence, we believe these fiscal and monetary policy efforts will likely remain a strong assurance
point for consumers and continue to be economic and market catalysts.
26WHERE WE STAND | U.S. ECONOMY
Potential Combined Fiscal and Monetary Stimulus
Enacted, Scheduled, and Proposed
Total = $13.5 Trillion
$14.0
Fed Monetary
$0.8 Expected Fed Balance Sheet
Expansion for 2021
$12.0 Support
$3.6 Fed Balance Sheet Expansion
(since March 2020)
$10.0
American Families Plan
$1.8
Trillions ($)
$8.0 Proposed Fiscal (proposed)
Stimulus
American Jobs Plan
$6.0 $2.3 (proposed)
American Rescue Plan Act
$4.0 $1.9 of 2021 (March 2021)
Enacted Fiscal
Stimulus $0.9 Consolidated Appropriations
$2.0 Act, 2021 (December 2020)
$2.2
CARES Act (March 2020)
$0.0
JOB GROWTH STILL HAS GROUND TO MAKE UP
Source:
Despite the strong recovery in the economy and expected acceleration of GDP growth in the
year ahead, it will still be some time before the U.S. job market fully recovers from the historic
toll of last spring, when 22.3 million people lost employment in less than two months during
March and April of 2020. As of the end of May 2021, the labor market has gained back 14.7
million of those lost jobs but still remains 7.6 million short of its peak just before the lockdowns
began. While future monthly trends are challenging at best to forecast, it is unlikely we will
see a complete recovery of the total jobs lost during the COVID-19 crisis until conceivably late
2022 or into 2023.
Jobs Lost and Recovered During Pandemic
Monthly Nonfarm Payrolls Jan. 2020-May 2021
May 2020 to May 2021 +14MM Jobs
+4.9MM
+2.8MM
+315k +289k +1.7MM +1.6MM +785k
+716k +680k +264k +233k +536k +278k +559k
-306k
-1.7MM
Net Jobs Lost = 7.6 million
-20.7MM
March & April 2020: -22MM Jobs
1/20 2/20 3/20 4/20 5/20 6/20 7/20 8/20 9/20 10/20 11/20 12/20 1/21 2/21 3/21 4/21 5/21 27
Source: BloombergWHERE WE STAND | U.S. ECONOMY
Since April of 2020, the unemployment rate has fallen from a post-World War II high of 14.8%
to 5.8% as of the end of May. While this progress is certainly impressive, there is still much
ground to be made before reaching the pre-virus low of 3.5% achieved in February of 2020.
For this reason, we believe monetary stimulus efforts will likely remain in place and fiscal
stimulus may still be pursued by the White House and Congress through at least the end
of 2022.
While monthly job gains throughout 1H 2021 have been extremely impressive by historical
standards, with more than 1.6 million jobs added since January, recent trends have been well
below expectations. Gains in nonfarm payrolls came in at 278,000 for April and 559,000 for
May, which for any other April and May would be considered spectacular, however consensus
estimates for these months had been for new jobs of 1 million and 720,000 respectively.
Recovery Still Seeking Full Employment
Unemployment Rate Feb 2020 – May 2021
16%
Apr 2020
15%
14.8%
14%
13%
12%
11%
10%
9%
8%
May 2021
7%
5.8%
6%
5%
Feb 2020
4%
3.5%
3%
2/20 3/20 4/20 5/20 6/20 7/20 8/20 9/20 10/20 11/20 12/20 1/21 2/21 3/21 4/21 5/21
Source: Bloomberg
This disconnect between expectations and reality could be a timing issue pertaining to a
worker shortage supply, as millions of individuals may currently be waiting for their additional
$300 per week benefit, as granted by the American Rescue Plan last March, to expire in early
September. As these additional benefits are being provided by the Federal government as aid
to state programs, those states have the authority to terminate these payments, and many are
now doing so. In recent weeks, 25 states have announced plans to end these benefits during
June and July, and this could result in rising job numbers between now and the fall with another
upshot in 4Q 2021.
While this theory is being fiercely debated, as many believe the shortage to be driven by
more pressing issues, such as lower wages, the need for child care, and continuing fear of
contracting the virus. Nonetheless, lower than expected job numbers in April and May clearly
appear to be the results of worker shortage as the labor-force participation rate (percentage
of the workforce employed or actively seeking employment) for May came in at just 61.6%,
continuing within a 60%–62% range created by the pandemic last year and reflecting the
lowest levels for this metric since the mid-1970s.
28WHERE WE STAND | U.S. ECONOMY
Labor Force Lags Historical Participation
Labor-Force Participation Rate (LPR) May 2011 – May 2021
65%
64.1%
64%
63%
62%
61.6%
61%
60%
5/11 5/12 5/13 5/14 5/15 5/16 5/17 5/18 5/19 5/20 5/21
Source: Bloomberg
ASSESSING THE RISKS TO ECONOMIC GROWTH
We view the following previously mentioned market concerns as potential downside risks to
our expected economic growth of 7% or better in the year ahead.
Rising inflation to the extent it surpasses a base-effects phenomenon, thereby appearing
to be structural and more prolonged in nature. This would include a secular shift toward a
longer-term and sustained trend north of 4% annualized well into 2022 and thus requiring
targeted policy action from the Fed. We currently view this risk as nominal.
Recent Inflation Creates Concern
Monthly Year-Over-Year CPI Jan. 2011 – May 2021
6%
5%
4%
3%
2%
1%
0%
-1%
2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021
Source: Bloomberg
29WHERE WE STAND | U.S. ECONOMY
Higher federal taxes capable of negatively impacting GDP growth by more than 2% annually and therefore
stalling expected economic momentum. For this to occur, we believe the previously communicated Biden tax
provisions would have to be passed in close to entirety and at currently proposed tax rates. Given the political
environment, we view this risk as nominal.
Longer-term interest rates spiking in excess of 3% on the 10-year Treasury yield and thus creating a strain
on the credit markets. Such a rise would of course have to be balanced against expected economic and earnings
growth accompanying the increase. We view this risk as minimal.
Change in monetary policy from the Fed. In the event the Fed reverses course, in terms of raising the fed funds
rates or completing its schedule of asset purchases during the year ahead, perhaps due to either inflationary
fears beyond a transient status or that of the economy overheating too quickly. Such a shift in policy could create
a loss of consumer confidence and impact growth. We view this risk as remote.
In conclusion, we see the U.S. economy accelerating impressively in the year ahead with CY 2021 posting better
than 7% GDP growth and CY 2022 perhaps in the 3%–4% range. This represents remarkable improvement
versus expectations of just months ago and is being driven by nationwide vaccine distribution, falling COVID-19
case trends, relaxed social distancing requirements, national business reopenings, and continuing fiscal and
monetary stimulus, all of which should result in the unleashing of large consumer pent-up demand in the trillions
of dollars. This will likely result in an official V-shaped recovery by year-end and a probable expansionary
environment as 2022 begins.
WHERE WE STAND: U.S. ECONOMY
• We believe the U.S. economy will likely post CY 2021 GDP growth north of 7% as large amounts of consumer
pent-up demand is unleashed during the remainder of the year.
• This should result in an officially recognized V-shaped recovery by year-end 2021, as real aggregate GDP
reaches record levels and surpasses the previous pre-pandemic high of CY 2019.
• More than $5 trillion of fiscal stimulus currently filtering through the system should act as an economic
tailwind with potentially more to follow if pending packages of another $3 trillion or so are passed by
Congress in 2H 2021.
• Though monetary policy will be the subject of debate and speculation, we believe the Fed will maintain
large-scale asset purchases into 2022 and maintain a lower bound of zero on the fed funds rate into 2023,
both of which should prove favorable for economic growth.
• While the economy has added more than 14 million jobs since April of last year, the labor market is still
running about 8 million jobs short of the pre-pandemic high, and for this reason we believe both monetary
and fiscal stimulus efforts will remain active into 2022.
• Risks to this growth scenario include non-transitory inflation, higher federal tax rates materially impacting
GDP, a major spike in longer-term interest rates, and an unexpected change in Federal Reserve monetary
policy — all of which we view as having probabilities of nominal to remote.
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