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What Will Be the Main Economic Drivers in 2021?

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This is an excerpt from our most recent Economic Outlook report. To access the full PDF, please click here.

 

With 2020 in the rear-view mirror, we are leaving behind us a plethora of events that affected and shaped our society and economy.

While the U.S. economy took some time to recover (and still might be recovering for a while) large cap U.S. equity indexes overcame the initial suppression shock very quickly and rallied back, leaving us all puzzling about the many reasons for the disconnect between Wall Street and Main Street. In hindsight, we note that 6 large cap growth tech stocks created 60% of the +40% annual lift in the Nasdaq 100 . Single stock day-trader focus is one easy answer.

Post-U.S. election announcements of 95% efficacy in Pfizer (PFE - Free Report) /BioNTech (BNTX - Free Report) and Moderna (MRNA - Free Report) vaccine results also led to buying up of the small cap Russell 2000 indexes in the risk markets. Giving one more time credence to the notion that particular stock investors operate based on expectations. “Influencers” price in any positive news a long time before any gets released. And then the “Band Wagon” gets crowded.

With that said, it appears more relevant than ever. We need to make sure you are made keen; aware of the major developments in the New Year; and how they will affect the U.S. economy; and its untethered financial markets.

What’s next is an outlook. To the key events (in our view) in 2021:

1) Arguably one of the biggest contributors to the U.S. stock market recovery in the past year was the swift action taken by the Fed to preemptively lower interest rates in anticipation of the massive impact on the economy. While similar to the 2009 Financial Crisis, we are lacking a control group to determine the exact effect this had on U.S. GDP. Still, it remains fairly obvious to us. Fed actions prevented the recession from turning into a depression.

What will be the path of the Fed going forward? While we can’t read the FOMC members mind’s, we can use the 2nd best thing, namely the Fed’s Dot Plot, chart summarizing the FOMC’s outlook for the federal funds rate, with each dot representing the interest rate forecasted by one of the 12 members of the committee. The chart is not binding in any form or fashion, but the median of the dots has historically been a reliable indicator of where we were headed.

You can see in the graph below. If you are expecting increasing Fed Funds rates, don’t hold your breath. We have been predicting ALL U.S. risk-free rates to remain at subdued levels for quite some time now. And we do not expect this FOMC, under this Fed Chair, to change course within the next couple years.

LOL...

Summary of Economic Projections for the Fed Funds Rate (2020 to 2023)




The biggest risk to that forecast? A build-up in core consumer inflationary pressures, which we continue to see as not very likely to be excessive, and exceed the Fed’s ‘symmetric’ mandate at +2.0% annually. Our expectation is that throughout 2021 the Fed will be determined not to rock the boat. The voting members will collectively remain as accommodative as possible towards the ongoing recovery process.

2) The Real Estate sector has been among the most affected areas of our economy during the last year, with densely populated areas such as Manhattan experiencing an exodus by residents to-wards the suburbs, as many employers allowed their employees to work remotely. The subsequent swath of empty office cubes created a large surplus in office space.

This was accompanied by a shortage in single-family (with nice remote home offices) supply in the suburbs, as relocation activity was driven be fear of the pandemic.

We expect these coupled developments to reverse throughout 2021. To a certain degree. The avail-ability of vaccines will slowly allow physical business activity (and entertainment options) to revitalize the inner metropolitan areas.

However, we do think that this extended remote-working experience will leave a lot of employers re-thinking the immediate need to rent expensive office space in the high prestige city centers, instead, providing more long-term flexibility for their work force. This will ultimately cause a shift in demand from non-residential towards residential real estate.

Put differently, demand for “tricked-out” homes, one’s that provide plenty of connected home office space, will increase in our view. This could counteract any increased supply in the residential space. Once many families – those that postponed needed plans to move – attempt to bring their homes on the market.

In aggregate, we foresee all these developments to balance each other out. To a certain degree. This should leave us with a slow but steady recovery in the real estate sector.

3) “David vs. Goliath” and “Growth vs. Value” were the major themes in the stock market throughout 2020.

Why?

First, large market capitalized companies seemed much better equipped to weather the storm – compared to their small counterparts – who had a much more difficult time overcoming the sudden loss of customer revenues, with fewer cash reserves built up.

Second, the Growth stock indexes, traditionally dominated by tech companies, was one of the big beneficiaries of the “work-from-home” economy. The Value sector was held back, as Energy and Financial sector firms, which serve as dominant index players, struggled.

Finally, the release of the early Pfizer/BioNTech vaccination results led to a return of optimism on Small Cap and Value stocks. That triggered a comeback rally. It is our expectation that, as a general note, this Small Cap and Value buying stock trend could continue. Uncertainty will begin to decline first. As the suppressed parts of the U.S. economy begin to decisively and irreversibly reopen. However, a far more important and predictable factor will arrive via sector performance.

Here is our concluding stock sector view. Cyclical Sectors that traditionally perform in-line or better, with a growing overall economy, will benefit throughout the New Year. As a result, they will be the main determinant of the overall stock market’s performance in 2021.

4) Ultimately, a topic that has NOT found its way to headlines for a while will make a comeback: Trade Negotiations with China.



With the global pandemic still shoving trade on the back burner, we do expect this to make its way to the front of the policy train for the new administration.

But the tone will certainly change.

It will nevertheless remain challenging to come to an agreement. Too many crucial aspects of the trade flows between both countries are at stake. A less ambitious, granular, agenda would be a better step to take. All international indexes will get a bid. If that critical bilateral trade tone improves.

 

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