Global securities markets delivered muted returns in the third quarter
Global securities markets delivered muted returns in the third quarter, apart from commodities, where energy prices continued to surge on higher demand and a shortage of supply. Third quarter global economic data indicated that the global expansion slowed, as supply chain disruptions and rising COVID-19 cases negatively impacted growth. The U.S. economy grew at an annualized rate of 2.0% in the third quarter, as a global chip shortage has impacted multiple industries and resulted in a lack of inventory that weighed heavily on the ability to consume goods, most notably motor vehicles.
Personal consumption remains strong
On the other hand, personal consumption remains strong with spending on services continuing to rise at a consistent pace during the third quarter. There is also mounting friction in the employment market, where record job openings imply a major shortage of labor, which is triggering significant wage inflation, particularly for lower income workers. Moreover, higher energy prices and rising rents may begin to weigh on disposable income. While a number of inflation metrics may have peaked, Wilshire maintains a favorable view towards commodities as we continue to see inflation as a notable risk, particularly given the implications on interest rates and corporate earnings.
Wilshire remains supportive on equities
We remain supportive on equities, but they believe that equity market return expectations are becoming increasingly reliant on a balance of earnings growth and interest rates, with limited potential upside related to multiple expansion. The evolution of financial conditions in response to monetary policy will likely have implications on market leadership across the investment landscape, most notably within the equity asset class.
The potential impact of tighter financial conditions
In this quarter’s Investment strategy update, we discuss the potential impact of tighter financial conditions on equities and fixed income, particularly given above trend growth and a consistently improving earnings outlook. This early-stage shift in financial conditions is likely to serve as a headwind for more expensive segments of the market, while serving to benefit cheaper assets such as foreign equities and U.S. value equities. This change in policy also introduces heightened interest rate risk, and therefore, we remain underweight duration risk (risk for longer term fixed income products e.g. a 30 year bond has more duration risk than a 1 year bond) and core fixed income in favor of more flexible/alternative mandates that exhibit less duration exposure. The environment is evolving quickly and may be met with higher levels of volatility in both fixed income and equity markets.
Wilshire continues to promote diversification
Wilshire continues to promote diversification and remains judicious in the allocation of our active risk budget, particularly as we witness market conditions reaching inflection points. We provide a summary of our positioning, rationale and supporting exhibits in the following sections.
Asset class perspectives November 2021
- Fixed Income vs. Equity. Despite a positive economic outlook, which would normally be expected to benefit equities coming out of a recession, valuations are not materially more attractive in equities vs. fixed income, resulting in a neutral posture.
- Large Cap vs. Small Cap Equities. We recognize that small caps are likely to benefit from an economic recovery, however given the dramatic level of recent outperformance in small caps, we believe that the early cycle recovery is mostly behind us.
- Global ex-U.S. vs. U.S. Equities. Given relatively attractive valuations in non-U.S. equities, improving COVID-19 conditions, and in combination with the more pro-cyclical exposure of foreign markets, we view non-U.S. equities as more attractive at this stage of the business cycle.
- Emerging vs. Developed Equities. While emerging markets have recently underperformed, the technical, fundamental, and geopolitical backdrop does not support overweight exposure to emerging markets relative to developed markets. Given our move to overweight foreign equities relative to U.S. equities, this change in our view of emerging markets is only resulting in a modest reduction of exposure.
Macroeconomic outlook: Supply chain disruptions weigh on global growth
> IMF forecasts strong real GDP growth
Third quarter global economic data indicated that global growth slowed, as supply chain disruptions and rising COVID-19 cases weighed on consumption. Despite this softening in growth, the IMF recently maintained expectations for global growth of 4.9% in 2022 and continues to upgrade its forecast for U.S. growth from 4.9% to 5.2% (Exhibit A).
> GDP slows on weaker consumption, net exports
The recent slowdown in economic growth in the third quarter was mostly attributable to weakness in personal consumption expenditures relative to prior quarters, as well as net exports (Exhibit B).
> Durable goods (motor vehicles) weighs on personal consumption
Looking more closely at personal consumption, durable goods contributed to a decline of -2.7% in real GDP (Exhibit C), which was almost entirely due to supply chain disruptions that resulted in a lack of inventory that weighed heavily on the sales of motor vehicles. Fortunately, consumer demand remains strong, as consumption of services contributed +3.4% to GDP.
> Services PMIs continue to signal expansion
Measures of economic sentiment are also continuing to signal expansion, as services PMIs across all of the developed world remain above 50, as shown in Exhibit D.
> Factories report slower deliveries
Nevertheless, the most recent ISM report showed that approximately 50% of factory purchasing managers continue to report slower deliveries, which is down from a high of nearly 60%, but indicates that friction in supply chains persist (Exhibit E).
Sentiment, technicals , and risk
The recent pickup in both equity market volatility and interest rate volatility is reflective of a market that is increasingly fixated on monetary policy, as the Fed begins to taper purchases of treasuries and mortgage-backed securities, and investors look for indications of when (not if) the Fed will begin raising interest rates in 2022. U.S. equities, most notably large cap growth companies, have benefited from extraordinarily easy financial conditions, as shown in Exhibit F.
We are likely to see a gradual reversal in such conditions in response to higher inflation and interest rates, and above trend economic growth. This shift in financial conditions is likely to serve as a headwind for higher valued segments of the market, while serving to benefit procyclical and cheaper equities such as foreign and U.S. value equities. These valuation dynamics are supportive of our decision to be underweight growth equities, and U.S. related to Non-U.S., as well as an underweight to fixed income and duration in the short-term.
This material, as well as the insights and data within, have been provided to MoneyLion by Wilshire Funds Management , Inc.
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