“Sixty years ago, Marshall Nirenberg and Henrich Matthaei began the process of cracking the genetic code. Thanks to their persistence and resilience, today’s scientists developed effective mRNA-based vaccines in record time, saving millions of lives from COVID-19. With the darkest days of the pandemic behind us, investors can also appreciate the resilience of the economy and financial markets and the hopeful prospect of brighter days ahead.” – Larry Adam, Raymond James Chief Investment Officer
As a backdrop, we’ll bring a bit of scientific language to our analysis this quarter as we celebrate the amazing feats of our scientific brothers and sisters. After all, as Carl Sagan said, “Science is more than a body of knowledge. It is a way of thinking.”
We begin with Isaac Newton’s Law of Motion, Force = Mass x Acceleration. Over the last year, we witnessed policymakers experiment with ways to force the economy out of its steepest dive since the Great Depression, applying massive fiscal and monetary stimulus at light speed. The Fed used the power of its record-setting $7.6 trillion (and growing) balance sheet while Congress voted $5.5 trillion of fiscal stimulus to fill the black hole COVID-induced lockdowns created. And the experiment’s not over yet. Chair Powell has said the Fed is “not even thinking of thinking about raising interest rates” as it downplays the risk of sustained, elevated inflation.
Meanwhile, Congress is in the midst of early negotiations for a multi-year ‘social’ and ‘physical’ infrastructure recovery package for later this year. With at least $2 trillion in excess disposable income and confidence growing, pent-up consumer demand should lead to a summer surge in economic activity. Given that consumer spending accounts for 70% of GDP, the demand for goods and services is the electromagnetic force that drives our economy. Of course, the biggest catalyst comes directly from medical science: enhanced COVID-19 vaccine availability and the related drop in cases, hospitalizations, and deaths are paving the way to a rapid, sustainable reopening of the economy. The stronger-than-expected force of these dynamics leads our economist to lift his expected 2021 GDP growth forecast to well over 5% from 4%.
Dissecting our growth forecast into major asset classes, we expect the supercharged economy (the best growth since 1984) to push both inflation and Treasury yields modestly higher. We’re forecasting the 10-year Treasury yield at 2% by year end, up from our original 1.5% estimate. We hypothesize continued Fed purchases, healthy demand from foreign investors, and the economy’s interest rate sensitivity to keep the rate beaker from boiling over beyond the 2% level and ruining the experiment.
Since the return profile of fixed income will be challenged in a rising rate environment, we continue to prefer investment-grade bonds over high-yield bonds. Dollar-denominated emerging market bonds may also be attractive, boosted by our expectation of a weakening dollar.