The world economy is set to accelerate later this year, but prospects are expected to vary regionally and by economies, according to success in responding to the COVID-19 pandemic. While China and EM Asia continue to lead the global recovery, Europe has struggled more to contain the virus, and given lingering structural challenges, is unlikely to return to pre-pandemic levels until 2022. In contrast, the U.S. outlook has brightened amid greater fiscal stimulus, and surprisingly limited signs of permanent damage to the economy which should allow for a faster and more durable recovery once the crisis is behind us. With vaccines availability becoming increasingly widespread and allowing for a return to more normal economic activity, U.S. GDP should return to pre-pandemic levels sometime later this year.
Fixed Income Outlook
An improving outlook as the virus moderates, vaccine distribution improves and a potential infrastructure bill continues to bias rates higher and create tailwinds to credit sectors. The Federal Reserve remains fully committed to its accommodative stance and letting inflation run above the 2% target. Recent concern about the Fed tapering asset purchases is premature in our view. Heavy demand for dollar-based fixed income assets both domestically and abroad will likely keep any rate rise limited. We continue to favor credit risk over rate risk for both corporate and municipal bonds as well as structured credit. Sector differences will likely be significant as the economy we are recovering to will be different than the pre-pandemic economy and we remain highly selective in the current environment.
Fundamental conditions remain positive. The economy is poised to strengthen this year as vaccine distribution becomes widespread, S&P 500 earnings are expected to reach all-time highs and the combination of central-bank and government stimulus will remain a tailwind. However, equity markets have been on an unprecedented run since last February’s lows and more volatility or even a correction in coming months is possible. Near-term risks include unexpected policy developments, rising interest rates and virus-related items. Given lofty valuations the expected recovery in earnings will likely be key for stock prices to take the next step higher. We continue to prefer U.S. stocks over non-U.S. developed markets and EM Asia over other emerging markets. While valuations in S&P 500 stocks appear full, other areas, especially in the high dividend paying stocks, look attractive to us and we are continuing to increase cyclical and mid-small Cap exposure in expectation of a developing multi-year expansion. We remain focused on high quality companies with strong business models selling at reasonable valuations.
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