The Macro View by Lionomics, November 2020

We work with Wilshire, one of the nation’s largest investment research consultants, to bring you investment advice and market insights. Each quarter in The Macro View, we summarize Wilshire’s viewpoint on the macroeconomic landscape and the asset classes that may make up the core components of your investment portfolio.

What’s macroeconomics, you ask? It’s the study of large-scale or general economic factors, such as interest rates and national productivity. Let’s dive into the latest quarter.

Tremendous rally for U.S. equities

Global equities have staged a tremendous rally on the coattails of global monetary and fiscal support, which have moved well ahead of earnings, thereby resulting in significant short-term multiple expansion. The rich valuations of global equities, particularly in the U.S., lends to a higher degree of market fragility or potential volatility in the near-term and indicates the need for corporate earnings to catch up to equity prices before we can expect to see any material upside in future returns. 

Although the future remains somewhat clouded with economic and political uncertainty, the global economy exhibited signs of a strong economic recovery during the third quarter, particularly in the U.S. The combination of immediate and targeted monetary action by the Fed, and an initial strong fiscal response by the U.S. government, supported a rapid recovery across most measures of economic activity in the U.S. 

While we are unlikely to witness a complete rebound in GDP to pre-COVID highs, it’s reasonable to expect +30% GDP growth (annualized) in Q3 (which was announced last week), which represents a very strong recovery relative to prior recessions. Coinciding with the strong recovery in economic growth, we continue to see a rebound in unemployment and inflation. The Fed maintains communication that it intends to remain very supportive through 2023, and in lieu of yield curve control, this anchoring of short-term rates is unlikely to keep long-term interest rates at these low levels. Despite the rebound to date, there is still uncertainty in areas of the economy and the need for business activity to continue to recover into the new year.

Arguably, the Fed’s current interest rate policy is likely to fuel higher economic growth and inflation, leading to an increasingly negative asymmetric risk/reward profile at the long-end of the yield curve, which will likely have implications on the equity risk premium (investors’ willingness to invest in riskier securities as an alternative to lower-yielding, less risky investments) and lead to a rotation in market leadership to more cyclically-sensitive parts of the market.

In this Macro View, we highlight Wilshire’s view of the trends in the economic recovery, specifically reviewing the substantial improvement in personal consumption, the case for further recovery in employment conditions, valuations in fixed income and equities, as well as the near-term implications of market sentiment on interest rates and the U.S. dollar. 

Asset class perspectives — MoneyLion portfolios

We’ve summarized Wilshire’s Q4 2020 viewpoint on the core components of MoneyLion members’ investment portfolios: 

Fixed income vs. equity

Wilshire will continue to evaluate market conditions and expectations over the coming months, with particular attention to the COVID crisis, global economic conditions, and the U.S. election.

Global ex-US vs. US equities

Despite attractive relative valuations in Non-U.S. developed market equities, the structural headwinds that Europe faces with a unified monetary policy applied to differentiated economies increases the uncertainty regarding its ability to recover from this downturn. Similarly, Japan has already been battling deflationary pressure for decades, and was only recently beginning to gain momentum. Furthermore, despite overwhelmingly negative sentiment for the dollar, we are beginning to see signs of technical support, and there is a growing possibility that we may not see as much fiscal stimulus as the market anticipates. This may result in future dollar strength, and weigh on non-U.S. equity returns in dollars. Therefore, Wilshire is remaining neutral.

Emerging markets vs. developed equities 

Emerging economies are forecasted to deliver stronger economic growth in 2021 and have historically outperformed coming out of recessions. While Wilshire is moving to an overweight view in emerging markets, they continue to actively reassess this view, particularly with the potential impact of the U.S. election and of foreign policy on large Emerging Markets constituents such as China. While emerging markets are a smaller part of portfolios, this serves as an important source of diversification and potential upside. 

Macroeconomic outlook: Signs of strong economic recovery

The global economy exhibited signs of a strong economic recovery during the third quarter. The IMF recently upgraded its estimates for global growth in 2021 to -4.4%, an improvement from the prior estimate of approximately -4.9%. Most of the recovery in global GDP growth is attributable to the significant rebound of the U.S. economy. 

The estimate for U.S. GDP growth was upgraded from -8.0% to -4.3% in 2020, with only modest improvements in most other developed market economies. The combination of immediate and targeted action by the Fed, and an initial strong fiscal response by the U.S. government, supported a rapid recovery across most measures of economic activity in the U.S.

The chart below shows the components of the U.S. GDP growth on a quarterly basis from Q1 of 2008 through Q2 of 2020. Unlike the global financial crisis of 2008-2009, the COVID crisis and ensuing recession resulted in a much larger decline in Personal Consumption Expenditures, primarily due to the forced shutdown of the U.S. economy earlier this year. Additionally, consumer savings rates increased throughout 2020, so it is important to see how the consumer spends money through the fourth quarter and the holiday season. 

Chart 1: COMPONENTS OF US GDP THROUGH 2Q20

Investor sentiment

Broad measures of risk are signaling limited systemic risk today, as credit spreads declined, liquidity improved, and interbank stress and corporate funding stress has subsided. While volatility has subsided in equity markets, the term structure of equity volatility continues to signal an expected increase in risk heading into the U.S. election, with expectations of much lower levels of volatility later this year and into 2021.

We are beginning to see a gradual change in sentiment in fixed income markets, as the U.S. 10 year Treasury yield has been rising off the lows of 0.50% over the past several months. The market has been pricing in very low implied interest rate volatility, particularly given the expectations that the Fed will maintain its current policy through 2023; however, we are beginning to see a pick-up in the level of short-term implied volatility, which is a risk that we are focused on. 

Outlook

As economic growth continues to improve, it is reasonable to expect a continued rise in longer-term interest rates. This further supports Wilshire’s decision to underweight traditional fixed income relative to its views on equity investments

The U.S. election may have implications on the future of U.S. economic growth, stimulus, tax policy, and regulation. Wilshire will continue to evaluate market conditions and expectations following the election.
As always, it is good investing behavior to keep a diversified portfolio, which MoneyLion members can maintain by choosing one of seven options based on their risk preferences. Additionally, investing on a recurring basis using Auto Invest allows MoneyLion members to stay consistent through macroeconomic developments without attempting to time the market.

Disclosure

Wilshire Funds Management (“WFM”) is a business unit of Wilshire Associates Incorporated (“Wilshire®”).

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