Affirming the Moderation
For investors, particularly equity investors, the past 15 months have been extremely rewarding. Over that time, domestic stocks have risen sharply as the Russell 1000 Index of large capitalization domestic stocks returned 34.9% and the small capitalization segment of the domestic equity market, as measured by the Russell 2000 Index, delivered an even more impressive return of 43.4%. International equities fared well also as the MSCI EAFE Index, which measures performance for developed markets, generated a return of 29.4%. As a result of these returns, an immense amount of wealth was created.
The U.S. economy has also experienced robust growth over the first four of this five-quarter time span. The period started with the impressive rebound performance of 33.8% in the third quarter of 2020 and the results over the next three periods have been more modest but still stellar with quarterly increases of 4.5%, 6.3%, and for the second quarter of 2021, 6.7%.
As has been well documented, the strength of economic recovery and financial market performance was driven in large part by aggressive moves taken on both the fiscal and monetary policy fronts. With the stimulus provided by this duopoly beginning to recede, along with some additional factors, the road to future growth is expected to migrate to a more modest pace. And this moderation is reflected in the estimates of economic growth for 2022. The current Bloomberg survey of economists estimates an increase of 4.2% for U.S. GDP next year, a decline from 2021’s anticipated rate of 5.9%, while the International Monetary Fund is projecting 4.9% for the global economy.
Fueling the Moderation
As mentioned before, the level of stimulus provided by monetary and fiscal policy is waning. For example, the Federal Reserve is widely expected to begin tapering its purchases of government securities by year-end. This is their first step in starting the process of removing monetary policy accommodation. Regarding the fiscal side of the house, some of the government sponsored benefits crafted to relieve economic pressure created by COVID have now expired. And the ability of Congress to pass significant infrastructure legislation continues to be challenging.
Speaking of COVID, it was a contributing factor to a slower rate of growth in the third quarter as reflected in the Bloomberg survey of economists conducted in September, which estimates an increase of 5.0% during the period. Supporting the thesis of slowing growth is the fact that Bloomberg’s August survey registered a consensus reading of 6.8% and that several economists reduced their estimates when the September survey was taken. Some estimates are as low as 2.0 – 3.0%. Specifically, the Delta variant of the coronavirus led some service-oriented segments of the economy to weaken. For example, fewer people passed through TSA checkpoints over the Labor Day holiday weekend than was recorded over the Fourth of July travel period. The impact of the Delta variant is, however, declining as a major factor in economic performance as COVID cases are showing declines in most regions across the globe while vaccination rates continue to increase. This development, along with progress being made in resolving supply bottlenecks, should allow a bounce back in fourth quarter GDP growth. But the aforementioned moderation in economic growth is still anticipated to take hold next year.
The Inflation Debate Continues
As the rate of inflation began to increase earlier this year, the move higher was defined as “transitory.” This term was used to acknowledge that a number of the factors causing price levels to rise would move toward the more modest levels seen prior to the pandemic and the policy response that ensued. While estimates for 2021 have been raised throughout the year, forecasts for 2022 indicate an expectation for inflation to move toward the more modest levels of the prepandemic period. Currently, the outlook for the Core PCE next year is 2.2% according to the most recent forecast from the Federal Reserve. This is a marked decline from the expected rate of 4.2% for 2021.
While we acknowledge that inflation may continue to register elevated readings longer than is currently anticipated, we continue to believe transitory is the correct term to accurately reflect how this rate will migrate in the future. In last quarter’s issue of Investment Insight, we introduced the Five Year, Five Year Forward Inflation Expectation Rate. This measure provides a market driven outlook of the expected inflation rate over the five-year period that begins five years from today. Currently that rate stands at 2.24%. Higher inflation may however turn out to be more than transitory. We will be monitoring developments on the inflation front over time and if price levels behave differently than expected, we will make the necessary adjustments across our various investment objectives.
Asset Allocation Review and Outlook
Since the completion of an allocation shift executed in the second quarter, we have maintained across each of our investment objectives the neutral status resulting from that shift. For each of our five objectives, this positioning results in allocations that align with our strategic benchmarks. This positioning equates to no overweight or underweight allocations involving underlying equity and fixed income exposures.
In terms of asset class performance, returns for the three-month period were lower than those generated in the prior quarter. U.S. equities, as measured by the Russell 3000 Index, declined 0.1% for the period. For equities outside the United States, the MSCI ACWI ex-US Index registered a return of -3.0%. And despite the recent uptick in interest rates, the Bloomberg Aggregate Bond Index return was essentially flat for the quarter.
As noted earlier, the rate of economic growth will moderate over time as various stimuli present over the past 18 months are beginning to recede. For now, we will maintain our current allocations but will monitor market movements, prospective policy changes and other potential developments to determine if new allocation shifts are warranted.
And, as always, we will close with a reminder for investors to review their current investment objective and accompanying asset allocation to ensure it best positions them to achieve their long-term goals and objectives.
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.