Pallett Wealth Management Team
Global Economic Update
Global markets have been relatively resilient through a summer period, despite significant global uncertainties. These include renewed political and geopolitical uncertainty, a fourth (and in some countries fifth) wave of COVID-19, moderating global economic growth and a U.S. Federal Reserve that appears to be on the verge of fine tuning its ultra-accommodative approach to monetary policy. We offer some brief thoughts on the issues that remain central to the investment outlook.
The general economy continues to learn how to function amid a pandemic that is nearly 18 months old. Activities are not yet back to normal, particularly for some pockets of the economy. Consumers, households and many businesses have adapted to make do, for the most part. Vaccinations have helped. While new cases are rising across many jurisdictions, the impact on hospitalizations and the economies of many countries has become less pronounced with each successive wave of the virus. As a result, investors are not as concerned as they once were. This trend of COVID-19 confidence may continue, barring any meaningful change in transmissibility and morbidity.
Economic growth in recent months has begun to slow. Part of this slowdown has been driven by new waves of the virus, but much of the slowing is the result of an inevitable reversion to the mean. The slowing explains the recent weakness in some pockets of the global investment markets such as commodities, cyclical sectors and currencies (such as the Canadian dollar).
Growth bounced back so strongly last year as a result of the economic reopening, pent up demand, excess savings and government support, but the pace was always destined to fade to a normal pace. The question is whether growth is simply leveling off to a more sustainable level, or the slowing could turn into something more prominent. We think that the former is more likely, based on recent economic data points and other factors. The global economy has yet to reach its full potential and could do so if the pandemic eventually turns into something milder or ends completely over the next year. There is still significant room for improvement in economic output and corporate earnings.
One of the primary economic supports has been global central banks. This is particularly true in the U.S., where the Federal Reserve has emphasized that it will do whatever it can to ensure a functioning credit market and sustainable economic recovery. Supports includes a program by which the Fed purchases billions of dollars of bonds every month to keep bond yields, and the cost of financing, relatively low. The Federal Reserve will begin to modify this program soon, given the progress made since last year. Regardless of timing, a change is in order, and it will mark the beginning of a gradual unwinding of its stimulus. While noteworthy, this does not suggest the conditions that have been so supportive to the recovery are set to deteriorate. In addition, any interest rate hikes still remain well over a year away. The transition from accommodative to more restrictive monetary policy is likely to take a few years to unfold.
The aforementioned issues have all bubbled to the surface in recent months. Yet, they have not deterred global equity markets, with many markets still sitting near their highs. The outlook remains constructive, given the diminishing impact from the virus, an economy that should continue to grow at a reasonable pace and a monetary policy backdrop that remains very supportive. Nevertheless, investors may want to temper their expectations with respect to investment returns. The sharp market rebound since last year, combined with valuations that are generally above average, suggest that forward-looking returns, while still reasonable, may moderate.
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