Investment Outlook

Global Economy Isn’t Yet Firing on All Cylinders

Pre-pandemic, the world economy ran like a finely calibrated machine. People readily crossed borders for business or leisure. Dependable and globally connected supply chains efficiently delivered parts and finished goods just in time to avoid excess inventory.

COVID-19 turned out to be the monkey wrench that caused critical components of this economic engine to fail.

Despite ongoing uncertainty, economic recovery is well underway as the pandemic’s second year winds down. Mobility is picking up, businesses are strengthening their distribution networks, and many of us have adopted new personal and work practices. This progress aligns with estimates that the global economy is on track to grow a robust 5.9% in 2021 before moderating in the new year.¹

This issue of our Investment Outlook highlights opportunities we’re finding in this environment and some of the risks dampening our 2022 viewpoint. 

Fiscal and Monetary Stimulus, Supply Bottlenecks, Rising Energy Prices and Wage Growth Push Inflation Higher

We began 2021 concerned the initial U.S. Consumer Price Index (CPI) reading of 1.4% didn’t accurately reflect the upward pressure on prices.

Despite the prevailing view that the rise would be temporary, our concerns came to fruition as inflation climbed steadily throughout the year. The 6.2% CPI reading in October was the highest since 1990.

Our Global Fixed Income team expects inflation to recede and settle under 3%, well above the sub-2% levels we’ve grown accustomed to in recent years.

Rising costs are weighing heavily on the minds of corporate executives. The number of S&P 500® companies mentioning inflation during the most recent earnings calls hit a 10-year high, according to FactSet.²

Expect Central Banks to Be More Active

In November, the U.S. Federal Reserve (Fed) began winding down its asset purchase program by $15 billion per month. If it continues tapering at this rate, the central bank could eliminate asset purchases by mid-2022, with the potential for rate hikes in the second half of the year or earlier.

Even before the Fed announced its tapering plans, we’d seen the yield on the 10-year Treasury note climb. We expect it to stabilize between 1.75% and 2%. This higher yield increases borrowing costs throughout the economy and tends to reduce the relative attractiveness of stocks compared to bonds.

Meanwhile, the European Central Bank (ECB) remains committed to holding interest rates at 0% and won’t hike rates until inflation stabilizes at 2%. Many emerging markets (EM) central banks, however, have started raising interest rates to control inflation to help prevent currency devaluations.

Companies Are Overcoming Higher Costs–So Far

Higher wages and the tight labor supply are pressuring companies across a broad swath of the market. For example, health care providers are telling our investment teams that staffing for hospitals and other facilities is so tight they’re paying temporary nurses up to five times more than their permanent nursing staffs.

Elsewhere, transportation costs are rising as trucking companies struggle to find drivers. And anyone who has been shopping or dined out recently won’t be surprised to learn that even with a $15 minimum wage in some locations, retail employers are having trouble recruiting workers at twice that pay.

So far, companies have been able to raise prices to cover their higher costs. During the third quarter, two-thirds of the largest U.S. companies delivered higher profit margins than they did before the pandemic.³ Earnings growth also was strong in Europe and Japan.

We think forecasts that margins will shrink during the next two quarters are too pessimistic. In our view, businesses willing to test the limits on how much they can raise prices before losing customers could maintain healthy profit margins.

Selectivity Will Be Paramount

After a remarkable year of recovery, we believe the global economy and markets are poised to return to more normal patterns in 2022. We also expect occasional volatility given the macroeconomic environment and continuing impacts of COVID. The market’s reaction to news of the omicron variant on November 26 is a good case in point.

We believe active security selection will make a difference under these conditions. For example, rising inflation highlights the importance of identifying companies with strong competitive positions and enough pricing power to pass along higher costs to their customers.

Also, given the higher yield on the 10-year Treasury, companies that generate significant current cash flows may hold up better than businesses whose cash flows are forecast far into the future.

In bond portfolios, we prefer short-duration corporate bonds that offer higher yields than government securities. And, for some investors, short-duration inflation-protected securities may provide a dual advantage of helping to reduce inflation and interest rate risk.

Thank you for entrusting us with your capital.

¹“World Economic Outlook,” International Monetary Fund, October 2021.

²John Butters, “Highest Number of S&P 500 Companies Citing ‘Inflation’ on Q3 Earnings Calls in Over 10 Years,” FactSet, November 12, 2021.

³Kristin Broughton, Theo Francis, “What Does Inflation Mean for American Businesses? For Some, Bigger Profits,” Wall Street Journal, November 14, 2021.