{"id":302,"date":"2021-04-26T19:57:24","date_gmt":"2021-04-26T19:57:24","guid":{"rendered":"https:\/\/winthropcm.com\/reports-and-profiles\/?p=302"},"modified":"2021-04-26T19:58:18","modified_gmt":"2021-04-26T19:58:18","slug":"2q-economic-capital-market-outlook","status":"publish","type":"post","link":"https:\/\/winthropcm.com\/reports-and-profiles\/2q-economic-capital-market-outlook\/","title":{"rendered":"2Q Economic & Capital Market Outlook"},"content":{"rendered":"\n

The Growing Risk of Two Forms of Capitalism<\/strong><\/h4>\n\n\n\n

Stock prices, by most measures, are hitting all-time highs. Interest rates, while on the rise, are still trading near historic low levels. American business, excluding the service sector, is booming. So, why should investors be concerned? The answer lies in the role of government-supported capitalism in the evolving shape of our democracy.<\/em><\/p>\n\n\n\n

Capitalism is the lifeblood for capital markets. It is the lubricant that allows companies to borrow debt and raise equity, and opens the door for investors to buy stocks and invest for retirement. The growing risk for investors has more to do with the competitive position of the United States in the global economy than job growth or inflation. The inconsistent vision for the American agenda guided by our democracy and the rules-based policies which support our form of capitalism are not effective enough to support economic growth over the next decade. In addition, the growing risk for our democracy is the income inequality that has widened over the past two decades through our form of capitalism.<\/p>\n\n\n\n

America is a divided country with two sets of incongruent ideals for the economy. The first perspective is that we are one country that needs to take care of our people. All individuals are represented. The contrasting view is that risk-taking should be rewarded, and success is allocated to those who achieve by taking risks. Democracy is for the individual; however, critics argue that our form of capitalism is stacked to favor the wealthy to the detriment of the poor. This results in the dramatic shift of government priorities and policies and lower levels of capital investment in business, resulting in a \u201ctake it now while we can\u201d form of capitalism to benefit shareholders.<\/p>\n\n\n\n

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So, every four or eight years we elect a new president that establishes a new vision for our country. At the same time, our Congress has imbedded gridlock in which one party is unwilling to get onboard with any aspect of the opposing party\u2019s vision for America. During the past 20 years, the political agenda has shifted back and forth, and these shifts have had a negative impact on domestic investment, taxes and foreign policy. The shifting agenda includes each administration\u2019s stance on corporate tax rates, military spending, national healthcare funding, as well as trade tariffs on specific countries.<\/p>\n\n\n\n

At the same time, we have navigated through two historic, seismic financial crises in the past two decades.<\/em> First, the 2008 Recession, which nearly took down the U.S. banking system, and second, the global pandemic in 2020, from which we are still emerging. The result is a massive pile of debt \u2013 more than $7 trillion to support households and businesses, and a normalization of the use of aggressive monetary and fiscal policy to support economic expansion. The government debt burden of the United States has increased from 60% of GDP in 2003 to 102% of GDP today, the highest debt measure following World War II.<\/p>\n\n\n\n

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Now, compare this to China, which enforces one driven, consistent policy initiative. China doesn\u2019t play by the global rules enforced by Western democracy. China steals intellectual property, restricts free speech, punishes dissidents. China\u2019s government produces consistent policies to support massive infrastructure spending and trade surplus, which in turn, supports economic growth. In China\u2019s form of authoritarian capitalism<\/em>, the government is the stakeholder and beneficiary in the company.<\/p>\n\n\n\n

This is not a criticism of China or the United States. Rather, it is a recognition that these two separate forms of capitalism operating in the global economy will clash over the next decade. In 1991, China\u2019s economy measured $383 billion compared to the United States economy at $6.2 trillion. By 2019, China\u2019s Gross Domestic Product (GDP) was $14.3 trillion, a growth rate of 13.8%, contrasted to   the U.S.\u2019s GDP of $21.4 trillion, or 4.5% growth. At this pace, China\u2019s economy will surpass the United States by the end of the decade.<\/p>\n\n\n\n

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As China\u2019s economic reach grows, the barriers to global trade will only increase. Their ability to sell electric cars, appliances, computer chips and technology under their terms will impact U.S. capitalism and reshape global investment opportunities.  <\/strong><\/p>\n\n\n\n

Economy<\/strong><\/h4>\n\n\n\n

The domestic economy is beginning to show signs of acceleration as we expected for 2021. Our base case scenario is that the vaccines will be effective in controlling the spread of the COVID-19 virus and that the economy will reopen in 2021 as more of the population is vaccinated and we approach warmer weather of summer. We are at the intersection of the acceleration of vaccine distribution with the decline in the spread of the coronavirus. <\/em>Supported by strong monetary and fiscal stimulus, we expect it to be a strong year for economic growth, and we expect Gross Domestic Product (GDP) to grow between 6.25% and 6.5% this year as the economy reopens.<\/p>\n\n\n\n

We are seeing improvement in manufacturing and consumer sectors of the economy. The IHS Markit Flash US Manufacturing PMI edged up to 59 in March of 2021 from 58.6 in February. The improvement in operating conditions was the second-fastest since April 2010, underscoring strong demand. However, supply chain distributions are impacting costs, and a lack of raw materials is contributing to pressure on vendor performance. At the same time, an increase in new business accelerated to the sharpest level since June 2014 while job creation remains strong.<\/p>\n\n\n\n

The semiconductor shortage across the globe is disrupting auto production, which was on pace for a very strong year. Both Ford and General Motors have announced production halts in order to address the semiconductor shortage in their supply chains.<\/p>\n\n\n\n

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Business confidence remains upbeat, as firms expect strong demand will support a rise in output over the next year amid stronger new order inflows and an anticipated end to the pandemic.<\/p>\n\n\n\n

Government programs and financial assistance have provided strong support for the consumer sector. With the distribution of $1400 stimulus checks for qualifying citizens during the past two weeks, we expect consumer spending to accelerate heading into the second quarter of 2021. The $900 billion stimulus program in December of 2020 provided strong support for consumers, causing a sharp 10.1% increase in household income according to the Commerce Department. While February saw a -7.1% drop in household income, we expect that March and April will once again show strength following the passage of Biden\u2019s Covid pandemic relief legislation. The relief package also provides an additional $300 a week in enhanced compensation for unemployed workers. We expect demand will remain strong through the year.<\/p>\n\n\n\n

We remain focused on whether the expected sharp increase in demand will push inflation up. The anticipation of stronger economic growth is pushing bond yields higher. At this point, we expect a shortage in labor in the fourth quarter as the service sector ramps up hiring, which will put short-term pressure on wages. However, we do not expect this to lead to sustained inflation.<\/p>\n\n\n\n

Emerging Markets<\/strong><\/h4>\n\n\n\n

Thirty years ago, MSCI rolled out its Emerging Markets Index. It has been a powerful tool to diversify portfolio asset allocation and gain exposure to smaller countries within the international space. However, in today\u2019s market, it represents a trap for investors who believe it\u2019s the same investment it was in the 1990s and 2000s. The MSCI Emerging Markets Index has concentration risk issues around country exposure and single-issuer exposure, which distort comparisons from earlier periods. In addition, the classification of China in a market-weighted index is problematic given the size of China\u2019s economy today.<\/p>\n\n\n\n

When MSCI first launched the Emerging Markets Index, Malaysia was the largest country with a market weight of 29.5%, Brazil was second-largest at 25.5%, and Mexico was third at 10%. In total, the three largest countries represented 55% of the Index. China was added to the index in 1996. In 2006, the three largest countries in the Emerging Markets Index were Korea 15.5%, Taiwan at 12.5% and China at 11.8% totaling 39.8% of the total index.<\/p>\n\n\n\n

Over the past 30 years, the MSCI Emerging Markets Index has added to its constituent countries, and its market capitalization has grown from a meager $15 billion in 1988 to more than $8.1 trillion today. The three largest countries are the same as in 2006, however the index has grown significantly more concentrated. China represents 39.5%, Taiwan represents 13.8%, and South Korea accounts for 13.2%. In total the three largest countries represent a staggering 67% of the index.<\/p>\n\n\n\n

Initially designed as a way to invest in smaller countries with growing economies, the MSCI Emerging Markets Index today is dominated by Asian countries. In fact, the countries that were represented in the original index in 1988 now represent less than 20% of the market value of the index.<\/p>\n\n\n\n

From December 31, 2000 through the end of February 2021, the weighted average annualized return of the MSCI Emerging Markets Index was 9.71%. However, during the past 10 years, the annualized return was 4.41%. The structural changes to the index are so great that any reversion to the mean comparison is meaningless. It\u2019s like driving the Indianapolis 500 and switching to a totally different race car every 100 laps, then trying to determine how the car performed during the race.<\/p>\n\n\n\n

The second issue concerns classifying China as an emerging market. When China was first included in the MSCI Emerging Market Index in 1996, its economy measured by nominal GDP was a mere $863 billion. At the same time the US economy was $8 trillion and Japan was $4.8 trillion. Today, the GDP of China is $14.3 trillion compared to the U.S. at $21 trillion and Japan at $5.1 trillion. China is the second-largest economy in the world.<\/p>\n\n\n\n

The third issue is the concentration of holdings in the South Korea and Taiwan indices. The largest holding in the South Korea index is Samsung at 22% and in the Taiwan index is Taiwan Semiconductor at 40%. This creates a bias as performance of the index and underlying ETFs are skewed toward the performance of these large holdings. <\/p>\n\n\n\n

At Winthrop Capital Management, we are addressing the changing makeup of the emerging markets by pulling out China as its own sleeve, so we can isolate it from the smaller countries in the index.<\/p>\n\n\n\n

Equity<\/strong><\/h4>\n\n\n\n

As we head into Q1 2021 earnings season, we expect corporate earnings to be strong across most sectors. The equity market in the first quarter was defined by the rotation out of the high-tech stocks that performed well last year into the companies that were greatly impacted by the pandemic. While we could call it a simple rotation into cyclicals, or value stocks, that description doesn\u2019t fully depict what is happening.<\/p>\n\n\n\n

March was a tough month for Apple, Microsoft, Amazon and Alphabet, but all are up more than 6% in April with a surge in big technology stocks. The stay-at-home stocks, such as PayPal, Etsy, ServiceNow and Autodesk, have been hardest hit this year but are having a strong resurgence in April. As long as the Federal Reserve is pouring money into the system, stocks should perform well. The choking point will be how rising interest rates impact valuations. Volatility has declined with the sharp rise in stock prices.<\/p>\n\n\n\n

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We expect that as long as the Federal Reserve is pouring money into the system, stocks should perform well. The choking point will be how rising interest rates impact valuations of financial assets including equities. <\/em> <\/p>\n\n\n\n

Fixed Income<\/strong><\/h4>\n\n\n\n

Growth and inflation expectations have driven rates across the globe higher over the first quarter. The 10-year U.S. Treasury began the year at 0.913% and is currently at its lowest of the year. The 10-year currently trades at 1.65%, after fading from a year-to-date peak of 1.74%. Global negative-yielding debt also peaked at year-end. After surpassing $18 trillion, negative-yielding debt has fallen to $14 trillion. While we see a case for U.S. rates to rise, we believe global rates will continue to stay compressed as their growth outlook faces substantial headwinds.<\/p>\n\n\n\n

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The slope of the yield curve underscores the significance of the economic recovery we are experiencing. The yield curve continues to steepen, and we expect the 2 \u2013 10 year spread to hit 200 bps. <\/p>\n\n\n\n

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Corporate bonds began the year at historically tight spreads, and they have continued to tighten as interest rates have risen. High yield spreads have tightened more than 50 bps as investors chase any yield they can find. The high yield index currently stands at 4.06%, the lowest yield ever despite a rising interest rate environment. While economic growth and credit look generally strong, markets are beginning to appear overvalued. We continue to hold credit across fixed income portfolios but are moving up in quality on the long end of the curve. This is done with a combination of A-rated corporates and U.S. Treasuries.<\/p>\n\n\n\n

With interest rates at historical lows, we see returns in fixed income markets compressed over the near term. We believe fixed income should still play a critical role in an asset allocation. It continues to be the most uncorrelated asset class to equities, and given the expanded valuations across stocks, bonds would provide risk mitigation in the event of a downturn. We prefer the upside in quality trade, and would caution income investors from chasing yield by taking on increasing credit risk.<\/p>\n\n\n\n

This report is published solely for informational purposes and is not to be construed as specific tax, legal or investment advice.  Views should not be considered a recommendation to buy or sell nor should they be relied upon as investment advice.  It does not constitute a personal recommendation or take into account the particular investment objectives, financial situations, or needs of individual investors.  Information contained in this report is current as of the date of publication and has been obtained from third party sources believed to be reliable.  WCM does not warrant or make any representation regarding the use or results of the information contained herein in terms of its correctness, accuracy, timeliness, reliability, or otherwise, and does not accept any responsibility for any loss or damage that results from its use.  You should assume that Winthrop Capital Management has a financial interest in one or more of the positions discussed.  Past performance is not a guide to future performance, future returns are not guaranteed, and a loss of original capital may occur.  Winthrop Capital Management has no obligation to provide recipients hereof with updates or changes to such data.<\/em> <\/em><\/p>\n\n\n\n

 <\/em>\u00a9 2021 Winthrop Capital Management<\/em><\/strong><\/p>\n","protected":false},"excerpt":{"rendered":"

The Growing Risk of Two Forms of Capitalism Stock prices, by most measures, are hitting all-time highs. Interest rates, while on the rise, are still trading near historic low levels. American business, excluding the service sector, is booming. So, why should investors be concerned? The answer lies in the role of government-supported capitalism in the […]<\/p>\n","protected":false},"author":3,"featured_media":101,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":[],"categories":[1],"tags":[],"_links":{"self":[{"href":"https:\/\/winthropcm.com\/reports-and-profiles\/wp-json\/wp\/v2\/posts\/302"}],"collection":[{"href":"https:\/\/winthropcm.com\/reports-and-profiles\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/winthropcm.com\/reports-and-profiles\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/winthropcm.com\/reports-and-profiles\/wp-json\/wp\/v2\/users\/3"}],"replies":[{"embeddable":true,"href":"https:\/\/winthropcm.com\/reports-and-profiles\/wp-json\/wp\/v2\/comments?post=302"}],"version-history":[{"count":2,"href":"https:\/\/winthropcm.com\/reports-and-profiles\/wp-json\/wp\/v2\/posts\/302\/revisions"}],"predecessor-version":[{"id":311,"href":"https:\/\/winthropcm.com\/reports-and-profiles\/wp-json\/wp\/v2\/posts\/302\/revisions\/311"}],"wp:featuredmedia":[{"embeddable":true,"href":"https:\/\/winthropcm.com\/reports-and-profiles\/wp-json\/wp\/v2\/media\/101"}],"wp:attachment":[{"href":"https:\/\/winthropcm.com\/reports-and-profiles\/wp-json\/wp\/v2\/media?parent=302"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/winthropcm.com\/reports-and-profiles\/wp-json\/wp\/v2\/categories?post=302"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/winthropcm.com\/reports-and-profiles\/wp-json\/wp\/v2\/tags?post=302"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}