Fifth Third Bank's teams of financial experts have identified anticipated economic trends for 2021. Read their thoughts.
This past year was filled with unpredictability, but 2021 may bring new opportunities, new growth, and new stability. Fifth Third Bank's team of experts – Jeff Korzenik, Chief Investment Strategist, Thomas Jalics, Chief Market Strategist, and Claire Rubin, Private Bank Investment Strategist – gathered their thoughts around some key economic topics for the year to come.
Remembering the Economy Before COVID-19
Before the COVID-19 Recession, the U.S. had seen more than 10 years of continual economic growth – leading many to expect a recession in 2020 or 2021 as part of typical economic cycles. Does the fact that this recession was triggered by the global pandemic – and not the usual ebb and flow of markets – change the outlook for a recovery?
Any recession is a reset, creating labor and manufacturing capacity that allows us to start a new growth cycle. The fact that this recession was triggered by an outside event means we may not have the slow, grinding process of working through fundamental imbalances – like we did with the housing inventory at the start of 2008. In theory, this would allow us to get back to the prior GDP peak quickly.
In practice however, this pandemic was highly disruptive – highlighting many dislocations that will take time to work through. As an example, there may be a need for more warehouse workers in order to support e-commerce, and fewer in-store retail employees. But even if the new jobs created are equal to the jobs that have been lost, differences in geography or skillset may still hinder smooth job transitions.
Prior to the outbreak of the Coronavirus, the U.S. economy was experiencing positive momentum driven by easing trade tensions, housing sector strength, low unemployment, and accommodative credit conditions. While the spread of the virus and the associated economic disruptions continue – lockdown measures did have a large negative effect on global economic output – the massive monetary easing by global central banks and unprecedented fiscal stimulus by developed nations have helped to cushion the blow.
Because of this, our view has been – and continues to be – the 2020 recession would be relatively short-lived (months, not years), and wouldn’t permanently impair the global workforce to the degree that, for example, the Great Depression did with a decade of double-digit unemployment.
Through the end of 2020, nations continue to carefully lift lockdown measures, despite recently renewed economic restrictions in the U.S. and Europe as virus cases have increased. Because there was no over-investment, bust, and subsequent credit overhang in an important sector of the economy (e.g. domestic housing during the great recession) the economy can emerge far quicker. We expect global economic growth to resume slowly and methodically as more restrictions are lifted, there is more action from global central banks, and anticipate this recession will be shorter than the experience of 10 years ago.
Historically, most market drawdowns and associated economic pullbacks come after months of weakening conditions. This recession was unusual in that it came as the global economy had been accelerating, and the U.S. economy had notable momentum.
In the first half of 2020, U.S. economic prospects still slowed considerably as social distancing and shelter-in-place orders were mandated across much of the country. The associated business disruptions led to a sharp rise in unemployment claims and a temporary halt in economic activity. Starting in May and continuing through October, most states have begun to slowly reopen their economies. We expect economic growth to resume in the back half of 2020 where the easing of economic lockdown restrictions can continue.
Overall, because we entered this recession without the typical imbalances that lead economic contractions, and because we had expansive fiscal and monetary regimes already in place that have now expanded, the U.S. economy will likely recover more quickly than past downturns. Economic output will return slowly, and perhaps unevenly, as nations relax restrictions and businesses reopen in a staggered manner.
Additionally, we expect financial markets to remain volatile as virus-related news ebbs and flows. The lesson from past epidemics is that economic growth and financial markets rebound once the spread of the pandemic is contained. That remains our expectation today.
What lessons from 2020 can we take and use moving forward and what lessons from 2020 can rightfully be considered anomalies, wholly unique, that likely won’t have major impact on trends and policy moving forward?
The sea change in how governments think about fiscal stimulus and monetary policy is likely to stay with us for many quarters – and perhaps many years:
- Western nations have exhibited the will to do whatever it takes to ensure the most severe effects of government-induced economic shutdowns would be mitigated.
- Central banks have lowered interest rates and began injecting liquidity to credit markets in the form of quantitative easing in order to incent borrowing and ensure credit markets remain functioning.
- Governments have added large amounts of stimulus to mitigate the negative effects of rising joblessness and economic stresses, and more is likely coming.
Outside of government actions, many trends have been supercharged during the pandemic, and may stay moving forward:
- Remote Working – If more companies permanently expand or adopt work-from-home policies, where companies are located and where people live could drastically change commercial and residential real estate. For example, we may see a migration of families from states with higher taxes to those with lower taxes
- Remote Learning and Shopping – Colleges and universities will have to adapt. Online sales went parabolic during the recession and will continue.
- Global manufacturing and travel – Reshoring of manufacturing could have significant longterm impact domestically. Public transportation, airlines and ride sharing all were negatively impacted and may need to reinvent themselves moving forward.
Fiscal stimulus can work. The types of support given directly to workers – and to employers to retain workers – was a very effective mechanism. And while it’s hard to compare the 2020 stimulus with the efforts of 2009 (this year’s was substantially larger), we may ultimately see that this recent stimulus was more effective overall.
The Fed’s new monetary policy framework, developed during the pandemic, will certainly have a long-term impact. More than simply saying that the rates will stay lower for longer, the Fed has made a commitment to running tighter labor markets for longer. We continue to believe that the acquisition, retention and development of talent will be a critical business skill over the next decades. Tight labor markets also can bode well for capital investment.
Impact of 2020 Elections
What impact might the new Biden administration have on economic growth and markets for 2021 and beyond?
Given our view that the Fed wants tighter labor markets, President-elect Biden’s choice of Janet Yellen for Treasury Secretary is quite interesting. She is very much on board with Fed chair Powell’s notion that hot labor markets produce desirable social outcomes like less income inequality. In fact, Yellen – a distinguished academic economic before her public service – was coauthor of a seminal 1990 paper noting the value of rising wages in increasing labor force participation rates, a component of long-term growth.
In general, a Biden administration’s policies will be pro-growth, but will seek to influence the direction of growth and apply more regulatory limits on corporations. For example, we would expect more focus on alternative energy. Some of these regulations can have negative disruptions, but the economic costs of those will likely be offset by less disruptive trade policies. This latter point should not be confused with going back to decade-ago China policies; there is broad bipartisan recognition that China was an abusive trading partner and that we need to geographically diversify our supply chain. The Biden administration will likely take a more multilateral approach to address that issue.
U.S. markets tend to prefer a partisan split in the federal government – either between the legislative and executive branches, or within Congress – as it prevents one party from moving forward with their own agenda completely uninhibited. Given that stimulus efforts have been held up in Congress during the current partisan divide, what impact might the two Senate seats in Georgia have for economic recovery specifically, as well as overall policy for the next two years?
In a scenario where one or both Senate seats in Georgia are won by Republicans – creating a divided government among the Biden administration, a Republican-majority Senate and a Democratic-majority House – we would expect the executive branch to increase regulation using executive orders or through setting a more regulatory tone within various federal government departments.
Expect regulation to be centered on financial institutions, the energy sector and healthcare:
- Financial institution regulation might include an increased focus on community investment, renewed scrutiny of non-bank financial institutions and expanded consumer protections.
- The energy sector might expect additional regulations discouraging fossil fuel exploration and the promotion of green energy initiatives, against a backdrop of more aggressive environmental regulation.
- Healthcare under this scenario would probably not see sweeping disruptive changes, but face a balance between provisions for increased coverage against scrutiny of healthcare prices.
Legislative accomplishments will be limited to areas of bipartisan agreement, with infrastructure investment the most likely beneficiary. A continued response to the COVID pandemic might include both financial support for displaced workers and perhaps some level of support for states and municipalities that alleviates some of the stress on their finances.
In Washington, it is often said that “personnel is policy,” but for roles that require Senate confirmation, continued Republican control – including at the committee chair level – would drive more middle-of-the-road appointments.
If both Senate seats in Georgia are won by the Democrat candidates, we suspect that this would seem to give a much wider latitude for legislative policy than under a split Congress. With a 50-50 political split in the Senate – and Vice President Kamala Harris being the tiebreaker – even if the filibuster is eliminated, moderate Democrat Senators will likely act as a brake on any particularly dramatic changes.
Regardless, tax policy will likely be front and center. President-elect Biden has proposed modest increases to the federal income tax for high-income individuals, dramatic lowering of estate tax exemptions, a corporate income tax that retraces half of the cut of the current administration’s tax reforms, and a near-doubling of capital gains taxes (and treatment of dividends) for high earners. Campaign proposals don’t always translate into legislation, but a Democratic majority in the Senate would reduce barriers to Biden’s tax plan.
In either scenario, we can expect more fiscal stimulus under any scenario. The stimulus will likely be larger with Democrats in the majority – but the timing of any stimulus is uncertain.
After major announcements from vaccine research companies stating more than 95 percent effectiveness of their Coronavirus vaccines during initial trials, an FDA-approved vaccine is now available – first to at-risk populations, front-line workers, and other targeted groups. What does that mean for economic recovery – especially as it may be several more months until a vaccine is widely available to the general population?
The availability of vaccines, even just to high-risk individuals, should bring down the fatality rate of COVID-19 dramatically – which limits the necessity of widespread shutdowns that would set back economic growth. These major developments in vaccines limit our concern about the possibility for a double-dip recession due to rising infections, hospitalizations and deaths.
So while short-term risk remains elevated given the surge in cases toward the end of 2020, medium-term it appears that Coronavirus risks are on their way down.
If by the first quarter of 2021 we can vaccinate the 20% of the population that is most vulnerable – the elderly and those with serious co-morbidities – we can drastically reduce the fatality rate and eliminate overburdening hospitals. We all will still need to be prudent and avoid the risk of infection – washing hands, wearing masks – but under this scenario, would be very little political will or rationale for more or continued severe economic lockdowns that threaten growth.
Prior to a vaccine making it to approval and wide distribution, governments across the world will continue to reopen their economies, while taking steps to contain the spread of COVID-19. Rising virus case counts in Europe, and now the U.S., are reasons to remain cautious on near-term economic activity.
In the U.S. virus case counts and hospitalizations are on the rise, and therefore prospective economic restrictions cannot be ruled out. Our expectation remains that any domestic lockdowns will be far less restrictive than in March, and that there will not be another mandated shutdown of non-essential businesses. Additional economic restrictions are rising in Europe as virus cases mount. These new restrictions appear to be far less onerous than in the spring, yet still put the continued economic expansion in question.
As case counts mount in the U.S., we expect economic restrictions to be concentrated in industries and sectors where it’s more difficult to readily socially distance: hotel, travel, airlines, cruise ships, restaurants, bars, sporting events, concerts, movies, plays. That’s the bad news. The good news is that these industries make up about 8.9% of total consumer spending ($718 billion annual spend in these industries, versus $8,047 billion total annual consumer spend). A meaningful amount of spend, but not a majority of consumer spending.
Looking Forward to 2021
When it comes to the Federal Reserve, will there be changes to their economic policies and approach in 2021? Will these changes likely be in place permanently, or are they strictly in reaction to the 2020 pandemic and recession?
While the aggressive reductions in interest rates and increases to the balance sheet the Fed took in response to the virus (more purchases possible to come in December) will fade as economic growth resumes, the shift to the Fed’s framework is likely here to stay.
The significant new policy framework for the Fed will now permit inflation over two percent for an extended period, and appears to tie any consequent tightening of interest rates additionally to unemployment falling below four percent.
The Federal Reserve has moved aggressively and rapidly to support the domestic economy by lowering interest rates and by implementing programs to increase credit market liquidity. This is in response to the COVID-19 outbreak which has dramatically slowed economic output, reduced inflation expectations, and tightened financial conditions.
In March 2020, the Federal Open Market Committee (FOMC) cut interest rates by a total of 150 basis points to a target range of 0.00% – 0.25% in emergency rate moves between scheduled meetings. Fed officials held rates unchanged through early November.
In August, in a major strategic shift, the Fed announced it will target inflation that averages 2% over time, reflecting a willingness to allow inflation to run higher and labor markets to run hotter by keeping interest rates lower for longer. The Fed indicated that the central bank does not intend to start normalizing interest rates until both its inflation goal and a return to 4% unemployment have been met.
Additionally, the Fed has committed to open-ended purchases of U.S. Treasuries, U.S. Mortgage and Commercial Mortgage-Backed Securities, (i.e. open-ended Quantitative Easing). Further, the Fed announced it will provide liquidity to support money market mutual funds, commercial paper, primary and secondary market corporate credit, primary dealers, and asset backed securities.
Market participants correctly read these actions as the Fed being willing to do “whatever it takes” to ensure properly functioning financial markets support the movement of credit to consumers and businesses.
What drove market growth in 2020, and how might that differ in 2021? What new areas of performance may investors see in the future? What areas lagged in the past that may outperform expectations in 2021?
Equity market performance for much 2020 has been driven by the outperformance of growth stocks and large cap U.S. technology names. In recent weeks, markets have been reversing year-to-date trends and rotating into value and cyclical names. Traditionally, value and cyclical stocks outperform at the start of an economic cycle. We expect this trend to continue in early 2021, which suggests small- and mid-cap domestic stocks will lead large-cap stocks.
Prospectively, forward-looking equity markets will continue to discount a future economic environment post COVID-19 where accommodative monetary and fiscal policy will act as supportive tailwinds, suggesting potentially higher equity prices.
Both emerging market and developed international equities continue to offer advantages on a valuation basis compared to domestic stocks. While acknowledging that risks have significantly risen in both the emerging and developed worlds, most economies can benefit from a relative abundance of available labor and industrial capacity – which should have positive implications for international equity investors prospectively, once fears of COVID-19 abate and central bank easing measures take hold.
Assuming at least the beginnings of an economic recovery and a widely available Coronavirus vaccine some time in 2021, what are some expected market trends for the year to come?
If we are correct in our assessment that the U.S., and the global economy, is emerging from the 2020 recession, then we are in the very early stages of a new economic expansion. If past is prologue, these economic expansionary periods typically last for many quarters and many years – which should lead to a continued grind higher in risk assets, and equities in particular.
From an investment perspective, we maintain tactical investment recommendations that modestly favor risk assets, including a modest overweight recommendation to the equity asset class.
The considerable move higher in global equity prices since March has reflected a combination of massive global monetary and fiscal stimulus (with potentially more forthcoming), economic data that has shown substantial improvement, perceived resolution on the domestic political front, and encouraging news on the COVID-19 vaccine front.
Our expectation remains that global stimulus measures will be kept in place for the intermediate term (18+ months) and that draconian global quarantine measures will not repeat. In addition to the considerable global monetary/fiscal stimulus, we see an environment with low interest rates (thus a low cost of capital), low inflation, and broad economic and company specific fundamental data that will continue to improve.
Disruptions create new opportunities, so we are at the very start of a new growth cycle in the U.S. economy. It will have its challenges – we expect tight labor markets will return sooner than expected, and the existing labor capacity may have the wrong skills, be in the wrong geography, or have the unfortunate taint of long-term unemployment.
It’s always important to keep demographic trends in mind, and for the U.S. these are relatively favorable. The Millennial generation, the largest cohort in our workforce, is coming into the time of their economic lifestyle (mid-30s) when they make rapid gains in their work productivity, compensation and consequent spending. They will be a powerful positive force in the U.S. for the next decade.