Foresight November 2021: macro themes and market outlook
Optimism around the reopening experienced during the spring and summer months has faded. In its place are questions around what the next few quarters will bring as policymakers’ and forecasters’ best-laid plans have gone astray: Pandemic-driven distortions have persisted longer than expected, creating uncertainty across several key areas, from production and inflation to labor market dynamics.
Overview: how long will these disruptions last?
At the heart of the issue is uncertainty around how long these disruptions, in all their forms, will last. The emergence of Omicron, the newest coronavirus variant, introduced yet more uncertainty into the macroenvironment, but it’s too early to have a clear sense of how this latest virus strain might affect the growth picture.
On the employment front, the roll-off of key unemployment benefits in North America could provide some answers around job scarcity in the next one to two quarters. Port blockages and restrictive policies in some countries make normalizing supply chains—and, by extension, prices—harder to discern. It’s clear that the length of these disruptions will have a profound impact on forecasts: The sooner the resolution, the more benign the medium-term outlook; conversely, the longer these issues drag on, the greater the likelihood of more permanent scarring in overall growth.
Over the longer term, we maintain that we’re likely to experience modest growth and monetary policy normalization. This expected return to stability and a rising interest-rate environment remain generally favorable to risk assets, with government bonds providing the least attractive return profile.
Five-year asset class forecasts—expected return components (%)
Source: Manulife Investment Management’s asset allocation team, October 2021. For more information, please refer to the important disclosures at the end of this report.
Sizable distortions persist
Supply chain disruptions are more pronounced than expected at this stage, creating ongoing scarcity of supply in everything from cars to labor. By extension, what had been considered transitory upward inflationary pressure is proving more persistent than most base-case scenarios—ours included. However, it’s worth noting that there’s probably limited read-through to shifts in monetary policy stances: Inflation driven by supply-side dynamics such as chip shortages or incremental pressure placed on energy prices (e.g., due to droughts) is unlikely to be affected by tighter policy. That said, the risk is that a scarcity of supply in certain areas could begin to weigh on growth.
Once we get past these distortions, the medium-term outlook is sanguine
Looking beyond the current uncertainties, we ultimately expect that an economic paradigm similar to what we experienced before the pandemic will reassert itself; that means modest but stable growth for an extended period, albeit with a slightly higher inflation profile. Against a backdrop of broad-based but gradual monetary policy tightening, this environment should remain broadly conducive for risk assets to outperform. Unfortunately, the timeline for this pattern to emerge appears to have been pushed back by a quarter or two as higher prices and shortages caused by supply chain disruptions are proving more persistent than anticipated.
Key central banks have started down the path to normalization
In the spring, the question facing central banks was when the first steps toward normalization would occur. Now, reducing the pace of quantitative easing (tapering) is a foregone conclusion at several key central banks, and attention has firmly moved toward when conventional policy tightening (interest-rate increases) will begin. Market expectations are that the U.S. Federal Reserve (Fed) and the Bank of Canada (BoC) will begin their tightening cycles around the middle of 2022. The Bank of England could begin before the end of this year, and the European Central Bank likely has a longer timeframe still, while there’s no evidence of meaningful removal of accommodation at the Bank of Japan.
There are, however, risks to this view: First, should the aforementioned macro disruptions persist, a weaker growth profile during the first half of 2022 could convince central banks to make a dovish pivot; alternatively, any rapid retreat in inflation would similarly alleviate pressure to normalize. Second, the recent announcement of Fed Chair Jerome Powell’s reappointment provides a measure of stability; however, there are still three senior positions to fill at the Fed, and the choice of appointments could influence policy in the coming years.
The search for yield will be as important as ever
Despite our belief that interest rates will gradually rise, they’re likely to stay near historical lows and struggle to exceed prepandemic levels over the next few years. With negligible expected returns in the fixed-income space, particularly in global government debt, asset classes that would provide additional yield are likely to remain in favor with investors. This is especially true for asset classes that can also provide diversification benefits. This perspective underpins some of our higher-conviction views, such as our overweight stance on emerging-market (EM) debt. It also explains why we have an improved outlook on certain alternative assets, such as global natural resources.
Tactical perspectives
(6–12 months)
Strategic perspectives
(3–5 years)
Source: Manulife Investment Management’s asset allocation team, October 2021. For more information, please refer to the important disclosures at the end of this report.
Fixed income
The Fed’s plans for tapering and hints that rate rises could take place earlier than expected at the beginning of the summer have been digested. From here, we maintain that interest rates should continue to move modestly higher as the global economy returns to a more stable state and central banks continue to normalize. In our view, the recent move up in yields following the Fed’s shift in tone has created a more even balance of risks, with a rally in bonds being a possibility should the Fed walk back some of its projected views in response to a deterioration in the growth/unemployment picture or a moderation in inflation. Overall, given the asset class’s weak return profile and the fact that the balance of risks is slightly to the upside (for yields), we maintain a modest underweight in this space. In the longer run, we believe that yields will continue to move modestly higher as the Fed continues to tighten monetary policy, warranting an underweight in the asset class.
The BoC’s policy stance has shifted markedly over the last six months: While tapering had already begun in the spring, the central bank’s expectation for Canada’s output gap to close in mid-2022 strongly implies that initial policy rate increases are likely to occur at about that time. We believe the BoC faces a more delicate balancing act than the Fed: High levels of public and private sector debt in Canada would suggest a slower pace of tightening. In our view, if the Canadian dollar (CAD) were to strengthen against the U.S. dollar (USD), as expected over the longer term, Canadian debt would be slightly more attractive than U.S. debt—if only marginally. Canadian corporate credit could offer marginally higher total returns relative to U.S. corporate credit for similar reasons.
We expect European and Japanese interest rates to continue to lag relative to the United States, largely a function of longer central bank normalization timelines and a more muted growth/inflation profile. We believe that normalization will inevitably push European and Japanese rates higher, particularly at the longer end, which will likely translate into headwinds in their respective bond markets. Crucially, on a currency-adjusted basis, we find Japanese fixed income slightly more attractive than European fixed income. Separately, we expect monetary policy movements in the United Kingdom to follow a timeline that resembles developments in North America as opposed to their European peers.
Being overweight in emerging-market (EM) debt remains one of our high-conviction views. We think the asset class could provide some of the most attractive expected total returns over both the short and long term, thanks to the relatively high level of expected income returns the asset class offers, coupled with additional support from a weaker USD. Although we’re forecasting a rising interest-rate environment in the coming years, we believe any change will be modest and that rates should remain near historical lows. This is likely to create an environment that should drive more flows into EM debt as the search for yield becomes more pronounced and the concept of carry becomes more important to investors. Over the shorter term, any cyclical recovery derived from an inventory rebuild and subsequent normalization should also support an overweight stance on EM debt. Regions such as Latin America are poised to benefit from global growth and rising demand for commodities. Finally, given our expectation for the USD to weaken over time, we have a slight preference for local currency debt over USD-denominated EM debt.
We maintain our favorable view of U.S. high-yield debt, largely due to the carry, which the asset class can offer in the current low interest-rate environment. While spreads relative to U.S. Treasuries are tight, we believe that the current economic environment should continue to support yields at or close to these levels, thereby enhancing the risk/return profile of the asset class.
In our view, positive carry from the asset class will likely outweigh any headwinds arising from higher interest rates, especially relative to government bonds. While we think that high-yield debt has a more attractive return profile than investment-grade credit, it’s worth noting that the latter asset class can be used as a tool for investors to add duration to their portfolios. Within this space, we have a preference for lower-rated credits, but we also believe it’s important to keep an eye on cross-country opportunities.
Equities
On a short-term basis, we believe that U.S. equities should continue to perform well through year end as consumer consumption remains healthy and manufacturing activities seem well placed to support the asset class. That said, high valuations remain a concern. As such, a moderate overweight stance is likely appropriate from a risk management perspective. On a structural basis, the United States has the healthiest long-term economic profile in the developed world; however, stock valuations and an expected depreciation in the greenback, particularly against other key developed-market currencies, remain headwinds to the asset class.
Higher oil prices and an improving outlook for Canadian financial services can provide attractive sources of upside for a significant portion of the equity market, making it an appealing asset class on a shorter-term basis. Despite a more modest long-term growth profile relative to the United States, we continue to find Canadian equities attractive because of the supportive dividend profile and reasonable valuations. They could also enjoy some upside from an expected appreciation in the CAD.
European equities should benefit from any inventory rebuild that occurs as supply chains begin to normalize. Valuations also remain intriguing relative to U.S. equities. Continued fiscal and monetary policy support should underpin the region’s growth prospects, while the European manufacturing segment—autos, in particular—should perform well as supply chains improve. Although the asset class might appeal from a dividends perspective, an expected appreciation of the euro could translate into additional modest tailwinds; it also must be noted that the region’s weak structural growth profile could dampen investor enthusiasm toward European equities.
This asset class is levered to manufacturing and the global trade impulse, which remains constrained by supply chain disruptions. Meanwhile, ongoing economic uncertainty in China, which represents a large part of the EM equities universe, is also a concern, as are political issues in Brazil. All things considered, we believe a near-term neutral stance is warranted; however, any evidence of improved supply chain dynamics, an inventory-fueled acceleration in production, a resolution of semiconductor chip shortages, or improved political stability could materially improve the outlook for EM equities, especially in view of compelling valuations. We continue to believe that EM equities remain appealing from a strategic perspective. Valuations remain inexpensive, and the asset class’s growth and dividend profiles are attractive over our five-year forecast period. A structurally weaker USD would also provide a modest tailwind to this asset class.
Japanese equities should, in theory, provide an intriguing opportunity to investors. Any procyclical move as a result of a global inventory rebuild, a weak yen, and continued massive monetary and fiscal support could provide support here; in practice, however, the asset class has proven disappointing in recent months. That said, we believe investors should nonetheless keep an eye on Japanese equities should any of the aforementioned factors begin to drive performance. Structural factors in favor of Japanese equities include inexpensive valuation, a possible appreciation in the yen, continued improvement in corporate governance, and generous share buyback programs; however, these factors are offset by Japan’s anemic growth profile. From a three- to five-year perspective, we continue to have a neutral view of the asset class, albeit with a slightly positive bias.
Chinese equities underperformed in recent months as a result of uncertainty around growth and perceived heightened geopolitical risks. In our view, any sign of stabilization of shifts in sentiment could lead to a period of outperformance here. We’ve long maintained that Chinese growth will need to decelerate in order to rebalance from its industrial growth model to a more consumer-centric one. We also expect the renminbi to depreciate modestly over the next three to five years. As such, we remain neutral on the asset class.
Alternatives/real assets
While we’ve upgraded our views on U.S. real estate investment trusts (REITs) since the depths of the pandemic, we’ve retained a cautious view. The great reopening—which, along with an improving macro backdrop, was seen as constructive here—has slowed. There continues to be notable dispersion across subsectors within the asset class, and the prospect of higher interest rates could also dampen investor appetite. That said, we believe REITs continue to deserve a place in a broader portfolio given their ability to offer higher yields—relative to fixed-income assets—and lower correlations to other asset classes.
Equity valuation within the global natural resources space has mainly been driven by the energy component. Oil and gas prices continue to climb higher, and recent inflation concerns have provided a catalyst for a resurgence in the price of gold, which we believe could continue for the next 12 to 18 months. Overall, we believe global natural resource equities are an example of a cyclical play and should outperform global equities at this point in the economic cycle.
Expected returns table
Fixed income: five-year forecast (%)
|
U.S. investment grade |
Canadian investment grade |
U.S. high yield |
U.S. leveraged loans |
U.S. TIPS |
Emerging-market debt |
Asia investment grade |
Global gov’t bond |
Income return |
2.4 |
2.3 |
5.3 |
4.9 |
1.2 |
5.5 |
3.3 |
0.9 |
Price return |
-1.3 |
-1.2 |
-3.1 |
-2.5 |
-1.6 |
-1.0 |
-1.1 |
-0.8 |
Currency return (vs. USD) |
-- |
1.5 |
-- |
-- |
-- |
0.2 |
1.1 |
1.2 |
Total return (USD) |
1.1 |
2.7 |
2.3 |
2.3 |
-0.5 |
4.7 |
3.3 |
1.4 |
|
||||||||
Currency return (vs. CAD) |
-1.5 |
-- |
-1.5 |
-1.5 |
-1.5 |
-1.4 |
-0.5 |
-0.4 |
Total return (CAD) |
-0.4 |
1.1 |
0.7 |
0.8 |
-2.0 |
3.1 |
1.7 |
-0.2 |
Developed-market equities: five-year forecast (%)
|
U.S. large cap |
U.S. mid cap |
U.S. small cap |
Canada large cap |
Canada small cap |
EAFE large cap |
EAFE small cap |
Global large cap |
Europe |
Japan |
Income return |
1.3 |
1.2 |
1.1 |
2.7 |
1.8 |
2.7 |
2.0 |
1.8 |
2.8 |
2.0 |
Nominal GDP/growth |
6.1 |
6.8 |
6.8 |
4.9 |
5.4 |
4.2 |
4.6 |
5.5 |
4.0 |
4.5 |
Valuation |
-5.0 |
-1.5 |
-1.5 |
-1.0 |
-0.5 |
-1.7 |
-1.0 |
-3.8 |
-2.0 |
-1.0 |
Currency return (vs. USD) |
-- |
-- |
-- |
1.5 |
1.5 |
1.5 |
1.8 |
0.5 |
1.4 |
2.0 |
Total return (USD) |
2.2 |
6.3 |
6.3 |
8.2 |
8.3 |
6.7 |
7.5 |
3.8 |
6.3 |
7.6 |
|
||||||||||
Currency return (vs. CAD) |
-1.5 |
-1.5 |
-1.5 |
-- |
-- |
-0.1 |
0.2 |
-1.0 |
-0.2 |
0.5 |
Total return (CAD) |
0.6 |
4.7 |
4.7 |
6.5 |
6.7 |
5.1 |
5.9 |
2.2 |
4.6 |
6.0 |
Emerging-market equities: five-year forecast (%)
|
Emerging |
Emerging Latin America |
Emerging EMEA |
Emerging Asia |
India |
China |
Hong Kong |
Taiwan |
S. Korea |
Singapore |
Income return |
2.1 |
3.4 |
3.7 |
1.8 |
1.0 |
1.7 |
2.8 |
2.7 |
1.6 |
3.0 |
Nominal GDP/growth |
7.1 |
6.1 |
5.6 |
7.6 |
9.2 |
6.7 |
4.8 |
8.7 |
8.6 |
4.2 |
Valuation |
-0.8 |
0.4 |
0.5 |
-1.0 |
-4.2 |
0.4 |
-0.2 |
-3.0 |
-1.2 |
-3.7 |
Currency return (vs. USD) |
0.5 |
0.6 |
-1.5 |
0.7 |
0.9 |
0.1 |
-- |
0.2 |
2.3 |
1.6 |
Total return (USD) |
9.0 |
10.6 |
8.1 |
9.0 |
6.6 |
8.9 |
7.4 |
8.4 |
11.3 |
4.9 |
|
||||||||||
Currency return (vs. CAD) |
-1.0 |
-0.9 |
-3.0 |
-0.8 |
-0.6 |
-1.4 |
-1.5 |
-1.3 |
0.7 |
0.0 |
Total return (CAD) |
7.3 |
9.0 |
6.5 |
7.4 |
4.9 |
7.2 |
5.7 |
6.7 |
9.7 |
3.3 |
Alternatives/real assets: five-year forecast (%)
|
U.S. REITs |
Global natural resource equities |
Global listed infrastructure |
|
Income return |
2.9 |
3.1 |
3.7 |
|
Nominal GDP/growth |
2.2 |
4.7 |
4.4 |
|
Valuation |
-0.6 |
0.2 |
-0.7 |
|
Currency return (vs. USD) |
-- |
0.5 |
0.5 |
|
Total return (USD) |
4.5 |
9.2 |
7.8 |
|
|
||||
Currency return (vs. CAD) |
-1.5 |
-1.0 |
-1.0 |
|
Total return (CAD) |
2.9 |
7.6 |
6.2 |
|
Model inputs are factors in Manulife Investment Management research and are not meant as predictions for any particular asset class, mutual fund, or investment vehicle. To initiate the investment process, the investment team formulates five-year, forward-looking risk and return expectations, developed through a variety of quantitative modeling techniques and complemented with qualitative and fundamental insight; assumptions are then adjusted for economic cycles and growth trend rates. The charts shown here may contain projections or other forward-looking statements regarding future events, targets, management discipline, or other expectations, and are only as current as of the date indicated. There is no assurance that such events will occur, and if they were to occur, the result may be significantly different from that shown here.
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