US Fed Chair Powell acknowledged that crisis-level monetary policy easing won’t be appropriate beyond the near-term as the economy recovers. This catalyzed a repositioning in markets with “inflation trades” tumbling. The US dollar rebounded from a five-year low. Long-term rates fell and growth stocks rallied.
Powell and the Fed hardly stand in the way of recovery. The Fed hasn’t even begun to phase out Quantitative Easing (QE). Under ideal economic conditions, a first rate hike is still 12 to 18 months away. Investors, however, are questioning an absence of further long-term US interest rate pressures at a time of rapid economic gains.
The early stage rebound in US services activity has added to other sources of growth. This likely represents the peak pace of gains in overall economic activity. The Atlanta Fed’s tracking estimate of US growth in the second quarter exceeds 10%.
Investors are looking beyond “one-off” stimulus and large distortions to the economy and see a moderate pace of underlying economic growth thereafter. Monetary policy will gradually be less accommodative, but won’t force real interest rates sharply higher. Unfortunately for bond investors, current interest rates, below even the last decade’s low inflation rate, provide poor returns even if valuations hold.
As we noted in our Mid-Year Outlook, portfolios should seek to transition from a sole focus on “Mean Reversion” to position for potential growth opportunities beyond COVID. We are not certain if valuation pressures have fully unwound in the US and Chinese tech sectors.
However, underweight positions have performance risks. True secular growth opportunities are clear in areas such as cyber-security, healthcare and green energy. While not pessimistic about valuations, we see our REIT investments as having come full circle from COVID-led declines, with a 32% gain over 12 months.
While some recovery opportunities remain, the dispersion of performance between different REIT groups is not likely to close between secular winners and losers. Mortgage REITS, with a 6% yield, still stand out as a solid (if volatile) alternative to fixed income.
Latin America shares are an overweight we’ve held since last April which has lagged behind other “recovery assets.” Shares have gained 63% in US dollar terms since April 2020 and 8% in the year-to-date. We view the region as well positioned for cyclical recovery, but “strategically challenged.”