Q2 2021 Market and Economic Perspective

At the beginning of the year, we considered global cooperation and an improved understanding regarding the importance of public-private partnerships to be potential silver linings of the pandemic. While it is too early to see evidence of that shift, we are troubled by the continued inconsistency surrounding the distribution of vaccines, as well as a disjointed approach to balancing the economic and public health implications involved in virus mitigation. The great reopening, if one could call it that, will be discussed later in this note, relies on a foundation that assumes COVID-19 infection rates will continue to decline and severe social restrictions will be a thing of the past. Virus variants, such as Delta, are created from mutations, which are more likely to occur if the virus is allowed to spread.

Optimists point to the fact that the infection, hospitalization and death rates have declined precipitously, and that many people globally should have some protection against the virus due to a previous infection or one of the COVID-19 vaccinations available. Pessimists, on the other hand, cite the still significant percentage of the global population that remains unvaccinated, with many in the developed world unwilling to take the vaccines due to a myriad of reasons. Even those who have followed the science and recommendations from sources such as the World Health Organization and the Centers for Disease Control have become a bit confused with messaging regarding mask wearing and the need for additional vaccine doses diverging over the past several weeks.

So, will the pandemic continue to be a concern during the back half of the year? Absolutely. While we maintain our view that widespread lock-downs in the U.S. are a thing of the past, the spread of more severe variants during the fourth quarter, as the northern half of the country moves back inside, could weigh on consumer sentiment and depress economic activity. In particular, companies with profits that are highly correlated with consumer spending such as travel and hospitality, could come under pressure if case rates begin to increase again. One could argue that anything is better than March and April of 2020 as it relates to COVID-19 activity, but stocks and bonds have already retraced to levels that assume an improvement in activity that by some estimates would be significantly stronger than 2019. Therefore anchoring expectations to the depth of the pandemic crisis response last year is, at this point, ill-advised.

In setting our outlook for the year, we cited the importance of politics and policy for the U.S. economy and markets during the back half of the year. We expected President Biden to be keen on quickly shifting focus to trade policy, particularly in light of the importance of global cooperation laid bare by the pandemic. While we acknowledged that Biden was unlikely to return to the Obama administration’s approach to trade, our view was that he would be interested in resuming discussions between trade representatives from the U.S. and China, in order to further progress on trade agreements following the January 2020 Phase One trade deal – provided that he was able to maintain his stance on protecting America’s trade interests.

Interestingly, Biden’s first six months have been marked by a very similar position to President Trump in terms of China trade – albeit with a markedly different approach. The majority of the tariffs that President Trump levied on China are still in place, and the Biden administration has become increasingly focused on facilitating the move from reliance on China in strategically important categories such as pharmaceuticals. While discussions have resumed between China and the U.S., with Biden’s support from key manufacturing states like Pennsylvania not far from his mind, it is unlikely that the U.S. is willing to budge too far, particularly given evidence that the Chinese have yet to meet the demands of the initial trade deal.

What has changed is that Biden is looking to foster stronger bonds with other trading partners in order to pressure Beijing even further. While Trump was focused on a concept of market access and equality and an “America First” approach, Biden has re-engaged with members of the G-7 to push on Beijing based on the country’s conduct outside of commerce – in particular around human rights offenses in the Xinjiang province and changes in China’s treatment of Hong Kong. In this vein, Biden is also looking to pursue new trade agreements with the European Union, the United Kingdom and Japan, as the global economy resets after the completion of the U.K.’s move out of the European Union.

Trade will undoubtedly remain in focus through much of this year and into next year, but in reality, the biggest impact from inside the Beltway on the U.S. economy this year and next will be the ongoing discussion regarding infrastructure spending and tax policy. The great blue wave that swept over Washington D.C. was expected to bring with it a storm surge of spending, however there are indications that some Democrats are not supportive of the size package that Biden proposed early in his term. Negotiations are ongoing, but if the current trend continues, the impact could be much more muted than initially expected.

There was no doubt in our minds that consumer spending would increase from the lows during March and April, 2020 and approach the level of spend prior to the pandemic, and that has occurred. The thesis behind the unleashing of pent-up demand driving a massive increase in U.S. GDP and positively impacting the equity markets has been borne out. Now the focus shifts to what happens next. The assumption of many market participants and economists is that the elevated level of consumer savings will slowly decline, and that decline will fuel more spending. But what will the nature of that spending be? Looking back over the last decade, spending has shifted from goods to services. During the pandemic, the balance shifted back as consumers globally, limited by social and travel restrictions, could not engage in the lifestyle spend that became an increasingly large proportion of their monthly outlay.

Stock prices for hospitality and travel businesses, as well as the noted challenges in hiring for restaurant, theme park, hotel and airline positions appear to support this shift back to services spending. However, other spending habits have changed as well. Household formation and home buying trends have accelerated, which at the very least could denote a shift to different types of businesses that are better supported in suburban and rural communities. It could also indicate an increase in spending for home maintenance, renovation and private education. International travel has been highly restricted, but with COVID-19 still a worldwide issue, a sharp increase in cross border travel and transactions could be a ways off.

What remains worth watching for the remainder of 2021 is how much of this great reopening has already been priced into the capital markets. Valuations appear rich, and more recently, the shine has come off the cyclical trade in favor of the big winners of the low growth, lower for longer rate environment that existed prior to the pandemic – namely, large cap technology stocks. The value trade enjoyed a solid 12 month rebound – but the end could be in sight already.

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