Easing Off the Accelerator
With continued progress being made in the fight against the coronavirus, GDP growth in the United States continues its recovery and has been moving higher at a rapid clip. Starting with the incredible reading of a positive 33.4% rate of GDP growth in the third quarter of 2020, the United States has readings well above trend in the current economic expansion. Following up on the blistering pace set in the third quarter of last year, momentum continued into the fourth quarter with a growth rate of 4.3% and most recently with the first quarter’s uptick of 6.4%. And we anticipate an acceleration to a 10.0% rate of growth for the recently ended second quarter. For the calendar year, FactSet Economics estimates a 6.5% increase in GDP. Looking outside the United States, the International Monetary Fund projected global GDP growth of 6.0% for this year in its World Economic Outlook released in April. The primary contributors to growth are a result of a combination of the progress being made in the battle against the coronavirus, the impact of fiscal stimulus, as well as ongoing monetary policy accommodation.
The recently ended second quarter is expected to represent the peak in GDP growth, excluding the rebound performance in the third quarter of 2020. Going forward, slower growth is anticipated with an eventual return to the more modest levels of expansion experienced prior to the pandemic. FactSet Economics is forecasting growth of 6.9% in the current quarter and 5.4% for the fourth quarter. For calendar year 2022, they currently estimate U.S. GDP growth at a rate of 4.0%. This slower rate of growth reflects the anticipation that pandemic infused pent-up demand will have been met for the most part and that supply chain bottlenecks will be well on their way to being resolved.
We will be monitoring several variables closely that could prospectively change this outlook. An unanticipated change to monetary policy and an outbreak of additional coronavirus variants are two of the primary scenarios we will be watching.
One of the key topics regarding the U.S. economic outlook is the recent acceleration in the rate of inflation and whether this acceleration is a short-term phenomenon or an issue that will prove to be more formidable long-term. As we have discussed in previous commentaries, we believe inflation will return to more modest levels as the current recovery continues to mature.
We are not alone in this assessment, as the survey of economists conducted by Bloomberg currently forecasts an increase of 2.5% this year for Core PCE, which is the Federal Reserve’s (Fed) preferred measure of inflation. The Fed is now forecasting a rate of 3.0% growth in Core PCE for 2021. Looking at forecasts for 2022 reveals a consensus across these two sources that results in a Core PCE increase of less than 2.5%. And it is not just economists who are demonstrating a muted level of concern regarding inflation; financial markets are also not currently indicating an expectation of sustained higher rates of inflation. The yield on the 10-year U.S. Treasury currently sits at 1.45%. Further evidence is provided by a measure called the Five Year, Five Year Forward Inflation Expectation Rate. As defined by the Federal Reserve Bank of St. Louis, the Five Year, Five Year Forward Inflation Expectation Rate is a measure of expected inflation (on average) over the five-year period that begins five years from today. The current reading of 2.21% suggests an inflation level that will continue to be modest as we move forward into the future.
Price reversals are another contributor to a more moderate inflation outlook. For example, as the month of June came to an end, lumber prices declined over 40% from their recent high. While its price is still substantially higher year-over-year, the decline still represents a meaningful step toward more modest price levels. Some agricultural commodities such as corn and soybeans have seen prices decline from recent highs as well. And in the U.S. Department of Agriculture’s recently released World Agricultural Supply and Demand Estimates Report for the 2021-22 year, both grains are expected to see prices lower than those currently seen in the spot market.
Asset Allocation Review and Outlook
During the second quarter, we executed an asset allocation shift across our balanced investment objectives. The shift entailed a reduction of equity exposure to a neutral weight with the proceeds of the reduction invested in the fixed income segment of portfolios. The primary profile of these objectives due to an analysis of the valuation levels that had been reached in the equity markets, particularly the U.S. equity markets.
We want to emphasize the shift did not reduce equity market exposure to an underweight position but rather resulted in an equity weighting that is in alignment with the strategic benchmarks assigned to our respective balanced objectives. As a result, neutral weightings and full participation in equity market performance is still present across these objectives. For the second quarter, this performance was 8.2%* for the Russell 3000 Index of domestic companies and 5.2% for the MSCI EAFE Index of developed foreign markets. As for the contribution made by the fixed income markets, it was positive as well with the Bloomberg Barclays Aggregate Bond Index returning 1.8% for the three-month period.
As always, there are numerous variables currently present across the investment landscape that could materially impact financial markets. We will be continuously monitoring prospective developments in the economy and financial markets and if additional shifts are deemed appropriate, we will execute those changes across our investment objectives or within specific asset classes.
In closing, we recommend investors review their current asset allocations and evaluate their continued appropriateness given their time horizon and risk tolerance.
* In the print edition of the Q2 2021 Investment Insight, the Russell 3000 Index return for the quarter was incorrectly published as 6.9%, it was actually 8.2%.
Source: BTC Capital Management, Bloomberg LP, Ibbotson Associates, FactSet, Refinitiv.
The information provided has been obtained from sources deemed reliable, but BTC Capital Management and its affiliates cannot guarantee accuracy. Past performance is not a guarantee of future returns. Performance over periods exceeding 12 months has been annualized.
The information within this document is for information purposes only and is not intended as an offer or solicitation with respect to the purchase or sale of any security. Statements in this report are based on the views of BTC Capital Management and on information available at the time this report was prepared. Rates are subject to change based on market and/or other conditions without notice. This commentary contains no investment recommendations and you should not interpret the statement in this report as investment, tax, legal, and/or financial planning advice. All investments involve risk, including the possible loss of principal. Investments are not FDIC insured and may lose value.