Capital Markets Outlook: 4Q:2021

29 10月 2021
2 Minute Read

What You Need to Know

The strong economic and market trends of the first half of 2021 wavered during the third quarter. The coronavirus delta variant caught up with the US at the height of the summer, just as vaccinations slowed and concerns grew that inflation might flare and persist. Even so, equity markets fared well until September. The quarter-end saw fault lines exposed in China’s real estate market, increased worries over inflation and a more definitive lean toward potential tapering by the Fed in November. We still expect strong global GDP growth this year, moderating in 2022, but cautions remain. For equity investors, quality is the watchword. And within taxable and municipal fixed income, credit makes sense.

4.0%
US Inflation 2021F,
2022F Slows to 2.3%
+15.9%
US Large Cap Returns
YTD 1/1–9/30
+5.9%
Revised 2021
Global GDP Forecast

The recovery continues, although September saw markets pull back from their August highs. We’ve revised our growth forecasts slightly lower, expecting the global economy to grow by 5.9% this year and 4.2% in 2022. Both forecasts remain well above the precrisis trend of 3.0%.

But the skew of risks around global growth has shifted markedly in recent months, from widespread optimism and upside risks to a more sober assessment of the outlook. China’s property market, the US debt ceiling and soaring energy prices in Europe all cloud the outlook. We’re also concerned that supply-side dislocations stemming from the coronavirus could be more pervasive and persistent than expected.

Of particular concern is the specter of a more challenging growth/inflation mix and a less certain outlook for monetary policy—one in which the only choices available to central banks are hard ones. The Fed is key. As we enter the fourth quarter, we share the view that inflation is likely to fall back next year. But upward pressure on prices has already been less transitory than expected, hinting at a more fundamental shift in inflation dynamics.

A robust earnings backdrop has strongly benefited equities, with over 87% of companies reporting earnings surprises. Certainly, valuations seem quite high, but the rise in earnings per share has actually lowered the overall P/E ratio. Warning signs did upset equities late in the quarter, and index concentration has reemerged, with the 10 largest companies in the S&P 500 now accounting for more than 28% of the index. The evolving economic cycles demand factor diversity. And regardless of style or capitalization, quality should be the focus—and selectivity is key.

Within fixed income, longer yields remained relatively unchanged, but with lots of intra-quarter movement. The yield curve began to steepen late in the third quarter in anticipation of higher yields. However, forward measures of expected inflation remain benign. In the current low-yield environment, investors will need credit exposure to exceed inflation. Despite tighter spreads, high yield continues to be useful, and defaults are forecasted to be quite low for the full-year 2021. Yields and spreads are tight in developed-market corporate credit, but relative opportunities exist, particularly in BB bonds and emerging-market bonds.

Munis posted negative returns for the third quarter, although they remain positive year to date. All eyes should be focused on upcoming events in the fourth quarter, including Fed tapering, Congressional spending bills and possible increases to corporate and personal tax rates. Flexibility may serve muni investors well—using a combination of high-yield and high-grade munis, including a portion of short-term high-grade bonds as potential liquidity to be opportunistic

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