WEBVTT 00:00:00.000 --> 00:00:04.464 align:middle line:90% [MUSIC PLAYING] 00:00:04.464 --> 00:00:07.440 align:middle line:90% 00:00:07.440 --> 00:00:09.940 align:middle line:90% Hello, this is David Kelly. 00:00:09.940 --> 00:00:12.185 align:middle line:84% I'm Chief Strategist here at JPMorgan Funds, 00:00:12.185 --> 00:00:13.560 align:middle line:84% and I head the team that produces 00:00:13.560 --> 00:00:15.330 align:middle line:90% the Guide to the Markets. 00:00:15.330 --> 00:00:17.070 align:middle line:84% Welcome to the Economic and Market Update 00:00:17.070 --> 00:00:20.290 align:middle line:90% for the First Quarter of 2022. 00:00:20.290 --> 00:00:22.840 align:middle line:84% At the start of a new year, the economy and financial markets 00:00:22.840 --> 00:00:25.860 align:middle line:84% are still being impacted by COVID-19. 00:00:25.860 --> 00:00:28.310 align:middle line:84% However, two years into the pandemic, these impacts 00:00:28.310 --> 00:00:30.850 align:middle line:90% are slowly beginning to fade. 00:00:30.850 --> 00:00:32.950 align:middle line:84% In part, this is because almost all Americans now 00:00:32.950 --> 00:00:35.680 align:middle line:84% have some immunity to the virus, either through inoculation 00:00:35.680 --> 00:00:37.378 align:middle line:90% or infection. 00:00:37.378 --> 00:00:39.670 align:middle line:84% However, it's also because the American economy has now 00:00:39.670 --> 00:00:42.325 align:middle line:84% adapted to the pandemic, with many people simply resuming 00:00:42.325 --> 00:00:44.200 align:middle line:84% their normal activities, and others adjusting 00:00:44.200 --> 00:00:45.783 align:middle line:84% their lifestyles to provide themselves 00:00:45.783 --> 00:00:47.560 align:middle line:84% with greater protection from infection, 00:00:47.560 --> 00:00:51.080 align:middle line:84% while still fully participating in the economy. 00:00:51.080 --> 00:00:53.290 align:middle line:84% This has allowed the US economy to fully recover 00:00:53.290 --> 00:00:54.580 align:middle line:90% from the pandemic recession. 00:00:54.580 --> 00:00:56.110 align:middle line:84% And, following a weak third quarter, 00:00:56.110 --> 00:00:59.660 align:middle line:84% economic growth is accelerating over the winter. 00:00:59.660 --> 00:01:02.330 align:middle line:84% This acceleration has prompted a sharp fall in the unemployment 00:01:02.330 --> 00:01:04.069 align:middle line:84% rate and has contributed to strong growth 00:01:04.069 --> 00:01:05.420 align:middle line:90% in corporate profits. 00:01:05.420 --> 00:01:07.160 align:middle line:84% However, it's also been accompanied 00:01:07.160 --> 00:01:09.410 align:middle line:84% by some of the strongest inflation seen in the past 40 00:01:09.410 --> 00:01:10.787 align:middle line:90% years. 00:01:10.787 --> 00:01:12.870 align:middle line:84% Both the economic improvement and higher inflation 00:01:12.870 --> 00:01:14.787 align:middle line:84% has prompted the Federal Reserve to accelerate 00:01:14.787 --> 00:01:17.072 align:middle line:84% the pace at which it's tapering its bond purchases 00:01:17.072 --> 00:01:19.530 align:middle line:84% and project multiple increases in short-term interest rates 00:01:19.530 --> 00:01:21.870 align:middle line:90% into 2022. 00:01:21.870 --> 00:01:24.030 align:middle line:84% Fiscal policy will also be much less supportive 00:01:24.030 --> 00:01:26.440 align:middle line:90% in the year ahead. 00:01:26.440 --> 00:01:28.300 align:middle line:84% Despite a less friendly Washington, 00:01:28.300 --> 00:01:30.670 align:middle line:84% US stocks saw a third consecutive year 00:01:30.670 --> 00:01:34.120 align:middle line:84% of very strong gains in 2021, while long-term interest rates 00:01:34.120 --> 00:01:36.430 align:middle line:90% only rose modestly. 00:01:36.430 --> 00:01:38.350 align:middle line:84% However, as interest rates rise further, 00:01:38.350 --> 00:01:40.820 align:middle line:84% and pandemic uncertainty falls in the year ahead, 00:01:40.820 --> 00:01:43.780 align:middle line:84% high valuations appear likely to limit long-term returns 00:01:43.780 --> 00:01:46.570 align:middle line:84% from both US equities and traditional fixed income, 00:01:46.570 --> 00:01:50.290 align:middle line:84% increasing the need for a more diversified approach. 00:01:50.290 --> 00:01:51.960 align:middle line:84% We believe any investment strategy 00:01:51.960 --> 00:01:53.550 align:middle line:84% should start with a broad assessment 00:01:53.550 --> 00:01:56.250 align:middle line:84% of these fundamental issues, which has, of course, always 00:01:56.250 --> 00:01:58.800 align:middle line:84% been the goal of the Guide to the Markets. 00:01:58.800 --> 00:02:02.020 align:middle line:84% However, it's important to do this concisely. 00:02:02.020 --> 00:02:03.630 align:middle line:84% There are over 60 pages in the Guide. 00:02:03.630 --> 00:02:05.820 align:middle line:84% But that's far too many for any conversation 00:02:05.820 --> 00:02:08.340 align:middle line:90% with an investor about markets. 00:02:08.340 --> 00:02:11.217 align:middle line:84% So what we do here is boil it down to just 12 slides. 00:02:11.217 --> 00:02:12.800 align:middle line:84% In particular, we start with an update 00:02:12.800 --> 00:02:15.408 align:middle line:84% on the course of the pandemic and fiscal policy. 00:02:15.408 --> 00:02:16.950 align:middle line:84% We then look at the pace of recovery, 00:02:16.950 --> 00:02:19.680 align:middle line:84% considering trends in economic growth, jobs, profits, 00:02:19.680 --> 00:02:21.210 align:middle line:90% and inflation. 00:02:21.210 --> 00:02:24.008 align:middle line:84% This is followed by comments on monetary policy. 00:02:24.008 --> 00:02:25.550 align:middle line:84% Finally, we consider the implications 00:02:25.550 --> 00:02:27.758 align:middle line:84% of all of this for those investing in US fixed income 00:02:27.758 --> 00:02:29.840 align:middle line:84% and equities, as well as international equities, 00:02:29.840 --> 00:02:31.548 align:middle line:84% and highlight the importance of investing 00:02:31.548 --> 00:02:35.450 align:middle line:84% in a diversified way in an evolving economic environment. 00:02:35.450 --> 00:02:37.850 align:middle line:84% Any assessment of the economic and market environment 00:02:37.850 --> 00:02:39.350 align:middle line:90% has to start with the pandemic. 00:02:39.350 --> 00:02:41.690 align:middle line:84% The left-hand side chart on slide 19 00:02:41.690 --> 00:02:44.300 align:middle line:84% shows the seven-day moving average of new confirmed cases 00:02:44.300 --> 00:02:46.050 align:middle line:90% and fatalities. 00:02:46.050 --> 00:02:48.158 align:middle line:84% After a decline last summer, cases and fatalities 00:02:48.158 --> 00:02:49.950 align:middle line:84% surged in the fall due to the Delta variant 00:02:49.950 --> 00:02:52.367 align:middle line:84% and could surge again over the winter due to the emergence 00:02:52.367 --> 00:02:54.410 align:middle line:90% of the Omicron variant. 00:02:54.410 --> 00:02:56.830 align:middle line:84% However, barring the emergence of some further dominant 00:02:56.830 --> 00:02:59.560 align:middle line:84% variant, both series should peak in the weeks ahead, 00:02:59.560 --> 00:03:01.870 align:middle line:84% reflecting more widespread immunity from vaccinations 00:03:01.870 --> 00:03:03.653 align:middle line:90% and prior infections. 00:03:03.653 --> 00:03:05.070 align:middle line:84% The right-hand chart of this slide 00:03:05.070 --> 00:03:06.810 align:middle line:90% provides some color on this. 00:03:06.810 --> 00:03:09.690 align:middle line:84% Coupling vaccinations with the total number of individuals 00:03:09.690 --> 00:03:12.690 align:middle line:84% who have already had the virus, we estimate that over 90% 00:03:12.690 --> 00:03:15.150 align:middle line:84% of the US population has at least some immunity 00:03:15.150 --> 00:03:17.590 align:middle line:90% to COVID-19. 00:03:17.590 --> 00:03:20.230 align:middle line:84% This should allow cases, and particularly fatalities, 00:03:20.230 --> 00:03:22.892 align:middle line:90% to fall in the months ahead. 00:03:22.892 --> 00:03:24.850 align:middle line:84% In addition, while the pandemic isn't over yet, 00:03:24.850 --> 00:03:26.433 align:middle line:84% many parts of the economy have adapted 00:03:26.433 --> 00:03:28.970 align:middle line:84% to operate in a pandemic environment. 00:03:28.970 --> 00:03:30.680 align:middle line:84% We all hope that the pandemic itself 00:03:30.680 --> 00:03:33.020 align:middle line:90% will fade as we move into 2022. 00:03:33.020 --> 00:03:34.580 align:middle line:84% But whether it does or not, it should 00:03:34.580 --> 00:03:36.500 align:middle line:84% have much less of an impact on the economy 00:03:36.500 --> 00:03:39.650 align:middle line:84% than it has had over the past two years. 00:03:39.650 --> 00:03:42.620 align:middle line:84% Apart from vaccinations, unprecedented fiscal stimulus 00:03:42.620 --> 00:03:45.020 align:middle line:84% from both the previous and current administrations 00:03:45.020 --> 00:03:46.940 align:middle line:84% has proven to be a powerful accelerant 00:03:46.940 --> 00:03:48.920 align:middle line:90% for the economic recovery. 00:03:48.920 --> 00:03:51.320 align:middle line:84% Indeed, legislation passed in the last two fiscal years 00:03:51.320 --> 00:03:54.360 align:middle line:84% has added $5.3 trillion to the economy. 00:03:54.360 --> 00:03:56.720 align:middle line:84% However, this stimulus is likely to drop sharply 00:03:56.720 --> 00:03:58.130 align:middle line:90% in the current fiscal year. 00:03:58.130 --> 00:04:00.320 align:middle line:84% Page 22 shows the impact of the recession 00:04:00.320 --> 00:04:02.210 align:middle line:84% and fiscal stimulus on the federal budget, 00:04:02.210 --> 00:04:04.085 align:middle line:84% according to the Congressional Budget Office, 00:04:04.085 --> 00:04:07.210 align:middle line:84% before accounting for the impact of the infrastructure bill. 00:04:07.210 --> 00:04:10.210 align:middle line:84% These forecasts also assume the individual tax cuts contained 00:04:10.210 --> 00:04:12.910 align:middle line:84% in the 2017 Tax Act expire on schedule 00:04:12.910 --> 00:04:14.908 align:middle line:90% in the middle of this decade. 00:04:14.908 --> 00:04:16.950 align:middle line:84% In addition, as we show in the table to the left, 00:04:16.950 --> 00:04:18.660 align:middle line:84% the CBO is assuming a continuation 00:04:18.660 --> 00:04:20.490 align:middle line:84% of very low long-term interest rates, 00:04:20.490 --> 00:04:23.160 align:middle line:84% even in the midst of economic recovery and huge deficit 00:04:23.160 --> 00:04:24.100 align:middle line:90% spending. 00:04:24.100 --> 00:04:27.007 align:middle line:84% However, even if we include an extension of the tax cuts 00:04:27.007 --> 00:04:29.340 align:middle line:84% and new benefits passed under the current administration 00:04:29.340 --> 00:04:32.310 align:middle line:84% and the last one, the deficit is likely to fall dramatically 00:04:32.310 --> 00:04:33.300 align:middle line:90% in the years ahead. 00:04:33.300 --> 00:04:35.400 align:middle line:84% In 2022, the economy should be much 00:04:35.400 --> 00:04:37.320 align:middle line:84% healthier than over the past two years, 00:04:37.320 --> 00:04:40.950 align:middle line:84% but it will also receive much less government support. 00:04:40.950 --> 00:04:42.630 align:middle line:84% The initial shock of the pandemic 00:04:42.630 --> 00:04:44.430 align:middle line:84% and the subsequent fiscal aid set off 00:04:44.430 --> 00:04:46.020 align:middle line:84% a wave pattern in economic output 00:04:46.020 --> 00:04:48.600 align:middle line:84% that has now lasted almost two years. 00:04:48.600 --> 00:04:50.935 align:middle line:84% Economic output fell in the first quarter of 2020 00:04:50.935 --> 00:04:52.560 align:middle line:84% and then plunged in the second quarter, 00:04:52.560 --> 00:04:54.227 align:middle line:84% with a peak-to-trough recession that was 00:04:54.227 --> 00:04:56.250 align:middle line:90% the deepest since World War II. 00:04:56.250 --> 00:04:58.410 align:middle line:84% However, output rebounded sharply after that, 00:04:58.410 --> 00:04:59.910 align:middle line:84% and the economy grew very strongly 00:04:59.910 --> 00:05:01.830 align:middle line:90% into the summer of 2021. 00:05:01.830 --> 00:05:03.720 align:middle line:84% Economic growth slowed again at that point, 00:05:03.720 --> 00:05:06.360 align:middle line:84% largely due to acute supply chain issues and the impact 00:05:06.360 --> 00:05:08.050 align:middle line:90% of the Delta variant. 00:05:08.050 --> 00:05:10.350 align:middle line:84% However, growth reaccelerated at the end of 2021 00:05:10.350 --> 00:05:13.200 align:middle line:84% and should continue to be very strong into early 2022, 00:05:13.200 --> 00:05:14.880 align:middle line:84% as reopening resumes and companies 00:05:14.880 --> 00:05:17.480 align:middle line:90% try to rebuild inventories. 00:05:17.480 --> 00:05:19.730 align:middle line:84% However, as we move further into the new year, 00:05:19.730 --> 00:05:22.130 align:middle line:84% real output looks likely to exceed the path estimated 00:05:22.130 --> 00:05:23.990 align:middle line:84% from its long-term pre-pandemic trend, 00:05:23.990 --> 00:05:26.180 align:middle line:90% indicating a full recovery. 00:05:26.180 --> 00:05:28.520 align:middle line:84% At that point, with a shortage of workers 00:05:28.520 --> 00:05:30.600 align:middle line:84% and much less fiscal and monetary stimulus, 00:05:30.600 --> 00:05:33.470 align:middle line:84% we expect economic growth to slow towards a long-term trend 00:05:33.470 --> 00:05:35.360 align:middle line:90% of roughly 2% annualized. 00:05:35.360 --> 00:05:39.200 align:middle line:84% In short, economic growth in 2022 should come in like a lion 00:05:39.200 --> 00:05:41.380 align:middle line:90% and go out like a lamb. 00:05:41.380 --> 00:05:43.030 align:middle line:84% The surge in GDP has been mirrored 00:05:43.030 --> 00:05:46.180 align:middle line:84% by a rebound in the labor market as the economy reopens. 00:05:46.180 --> 00:05:49.150 align:middle line:84% After shedding an astonishing 22.4 million jobs 00:05:49.150 --> 00:05:51.430 align:middle line:84% between February and April of 2020, 00:05:51.430 --> 00:05:55.360 align:middle line:84% the economy has now recovered 18.4 million jobs, or 83% 00:05:55.360 --> 00:05:56.935 align:middle line:90% of the total pandemic loss. 00:05:56.935 --> 00:05:59.560 align:middle line:84% That being said, the job market recovery is not quite complete, 00:05:59.560 --> 00:06:01.480 align:middle line:84% with the unemployment rate at 4.2%, 00:06:01.480 --> 00:06:04.180 align:middle line:84% compared to 3.5% before the pandemic. 00:06:04.180 --> 00:06:07.090 align:middle line:84% While this might suggest that a small amount of labor slack 00:06:07.090 --> 00:06:10.400 align:middle line:84% remains, wages tell a different story. 00:06:10.400 --> 00:06:12.220 align:middle line:84% The blue line shows the annualized growth 00:06:12.220 --> 00:06:14.500 align:middle line:90% in average hourly earnings. 00:06:14.500 --> 00:06:16.375 align:middle line:84% Wage growth has been rising and is 00:06:16.375 --> 00:06:19.570 align:middle line:84% at annualized rates not seen since the 1980s. 00:06:19.570 --> 00:06:21.610 align:middle line:84% Putting this together with surging labor demand, 00:06:21.610 --> 00:06:24.010 align:middle line:84% this suggests the employment shortfall is primarily 00:06:24.010 --> 00:06:25.840 align:middle line:90% an issue of labor supply. 00:06:25.840 --> 00:06:28.780 align:middle line:84% Labor supply has been slower to recover as the economy reopens, 00:06:28.780 --> 00:06:30.280 align:middle line:84% and this has likely been constrained 00:06:30.280 --> 00:06:33.130 align:middle line:84% by enhanced unemployment benefits, lower immigration, 00:06:33.130 --> 00:06:36.495 align:middle line:84% higher costs for child care, and lingering pandemic fears. 00:06:36.495 --> 00:06:38.620 align:middle line:84% This is an important issue for the Federal Reserve, 00:06:38.620 --> 00:06:41.290 align:middle line:84% as higher wages should lead to higher inflation, 00:06:41.290 --> 00:06:44.620 align:middle line:84% implying that the economy could reach maximum employment sooner 00:06:44.620 --> 00:06:47.140 align:middle line:90% than in past economic cycles. 00:06:47.140 --> 00:06:48.790 align:middle line:84% Overall, while the labor shortage 00:06:48.790 --> 00:06:50.560 align:middle line:84% is likely to persist for some time, 00:06:50.560 --> 00:06:52.923 align:middle line:84% we expect some of these pandemic effects to recede. 00:06:52.923 --> 00:06:54.340 align:middle line:84% And this should allow unemployment 00:06:54.340 --> 00:06:58.830 align:middle line:84% to fall below 4% in the first half of 2022. 00:06:58.830 --> 00:07:01.260 align:middle line:84% The deep economic recession was mirrored 00:07:01.260 --> 00:07:03.750 align:middle line:84% in big declines in S&P 500 operating earnings 00:07:03.750 --> 00:07:05.580 align:middle line:90% in early 2020. 00:07:05.580 --> 00:07:07.680 align:middle line:84% However, as shown on page 8 of the Guide, 00:07:07.680 --> 00:07:09.600 align:middle line:84% earnings have now recovered spectacularly 00:07:09.600 --> 00:07:12.600 align:middle line:84% and hit a new all-time high in 2021. 00:07:12.600 --> 00:07:14.550 align:middle line:84% This partly reflects the reality that some 00:07:14.550 --> 00:07:16.870 align:middle line:84% of the most important sectors of the US equity market, 00:07:16.870 --> 00:07:19.290 align:middle line:84% including technology, communication services, health 00:07:19.290 --> 00:07:21.900 align:middle line:84% care, and consumer staples, saw few negative impacts 00:07:21.900 --> 00:07:25.043 align:middle line:84% from the pandemic and, in many cases, saw stronger revenues. 00:07:25.043 --> 00:07:26.460 align:middle line:84% More generally, earnings have been 00:07:26.460 --> 00:07:29.520 align:middle line:84% bolstered by powerful consumer demand and higher productivity, 00:07:29.520 --> 00:07:31.710 align:middle line:84% as businesses have been able to reduce costs 00:07:31.710 --> 00:07:33.730 align:middle line:90% in a more virtual environment. 00:07:33.730 --> 00:07:38.080 align:middle line:84% However, entering 2022 and beyond, things will get harder. 00:07:38.080 --> 00:07:40.960 align:middle line:84% We're headed toward slower economic growth, higher wages, 00:07:40.960 --> 00:07:42.870 align:middle line:84% higher interest rates, and potentially higher 00:07:42.870 --> 00:07:44.520 align:middle line:90% corporate taxes. 00:07:44.520 --> 00:07:46.800 align:middle line:84% Consequently, investors should consider valuations 00:07:46.800 --> 00:07:49.680 align:middle line:84% very carefully, as the potential for further earnings growth 00:07:49.680 --> 00:07:51.938 align:middle line:90% looks much more modest. 00:07:51.938 --> 00:07:53.480 align:middle line:84% Inflation has heated up significantly 00:07:53.480 --> 00:07:56.090 align:middle line:84% over the past year as surging consumer demand has 00:07:56.090 --> 00:07:58.340 align:middle line:84% collided with supply shortages across major sectors 00:07:58.340 --> 00:07:59.720 align:middle line:90% of the economy. 00:07:59.720 --> 00:08:01.223 align:middle line:84% CPI inflation has been accelerating 00:08:01.223 --> 00:08:03.140 align:middle line:84% since the start of the summer, with the latest 00:08:03.140 --> 00:08:08.000 align:middle line:84% year-over-year gain in CPI at 6.8% overall and 4.9%, 00:08:08.000 --> 00:08:09.885 align:middle line:90% excluding food and energy. 00:08:09.885 --> 00:08:11.510 align:middle line:84% These year-over-year gains in inflation 00:08:11.510 --> 00:08:14.270 align:middle line:84% have been amplified by weak increases in prices a year ago. 00:08:14.270 --> 00:08:17.220 align:middle line:84% But supply chain issues have been a problem. 00:08:17.220 --> 00:08:19.230 align:middle line:84% In particular, the global semiconductor shortage 00:08:19.230 --> 00:08:20.760 align:middle line:84% has increased prices of a wide range 00:08:20.760 --> 00:08:24.603 align:middle line:84% of goods throughout the economy, and most notably autos. 00:08:24.603 --> 00:08:26.770 align:middle line:84% These higher input costs have sent inflation higher, 00:08:26.770 --> 00:08:29.350 align:middle line:84% and this has been amplified by a general recovery in prices 00:08:29.350 --> 00:08:33.490 align:middle line:84% of airfares, restaurants, and rents from their pandemic lows. 00:08:33.490 --> 00:08:35.919 align:middle line:84% Fiscal support for lower- and middle-income households 00:08:35.919 --> 00:08:37.870 align:middle line:84% has also bolstered the demand for food, 00:08:37.870 --> 00:08:40.299 align:middle line:84% leading to higher food prices, while a spike in oil 00:08:40.299 --> 00:08:42.549 align:middle line:84% prices to over $80 a barrel in October 00:08:42.549 --> 00:08:46.030 align:middle line:84% boosted the volatile energy components of CPI. 00:08:46.030 --> 00:08:48.037 align:middle line:84% Importantly, the PC deflator, which 00:08:48.037 --> 00:08:49.870 align:middle line:84% is the Fed's preferred measure of inflation, 00:08:49.870 --> 00:08:52.360 align:middle line:84% is up by more than 5% year over year, well 00:08:52.360 --> 00:08:55.425 align:middle line:84% above the Fed's long-term target of 2%. 00:08:55.425 --> 00:08:57.550 align:middle line:84% We believe that much of the current inflation surge 00:08:57.550 --> 00:09:00.490 align:middle line:84% will prove transitory, including the energy and supply chain 00:09:00.490 --> 00:09:01.670 align:middle line:90% issues. 00:09:01.670 --> 00:09:04.540 align:middle line:84% However, the impacts of higher wage growth, rising rents, 00:09:04.540 --> 00:09:07.420 align:middle line:84% and generally higher inflation expectations should linger. 00:09:07.420 --> 00:09:08.920 align:middle line:84% And this should imply inflation that 00:09:08.920 --> 00:09:10.990 align:middle line:84% is well above 2% for the remainder 00:09:10.990 --> 00:09:13.563 align:middle line:90% of this economic expansion. 00:09:13.563 --> 00:09:15.730 align:middle line:84% Since the start of the pandemic, the Federal Reserve 00:09:15.730 --> 00:09:17.590 align:middle line:84% has provided significant monetary stimulus 00:09:17.590 --> 00:09:20.050 align:middle line:84% by cutting the federal funds rate to near-zero levels 00:09:20.050 --> 00:09:22.030 align:middle line:84% and adding substantially to its balance sheet, 00:09:22.030 --> 00:09:25.690 align:middle line:84% with $120 billion of bond purchases at a maximum 00:09:25.690 --> 00:09:27.160 align:middle line:90% each month. 00:09:27.160 --> 00:09:30.580 align:middle line:84% At the November meeting, they'd cut purchases to $105 billion 00:09:30.580 --> 00:09:33.610 align:middle line:84% monthly in recognition of the progress the economy had made 00:09:33.610 --> 00:09:36.400 align:middle line:84% towards their goals of maximum employment and inflation 00:09:36.400 --> 00:09:39.010 align:middle line:90% running a little bit above 2%. 00:09:39.010 --> 00:09:40.840 align:middle line:84% At its December meeting, the FOMC 00:09:40.840 --> 00:09:43.000 align:middle line:84% delivered a significantly more hawkish message, 00:09:43.000 --> 00:09:44.980 align:middle line:84% recognizing that the Delta variant had slowed 00:09:44.980 --> 00:09:48.310 align:middle line:84% economic progress, but also that the labor market recovery has 00:09:48.310 --> 00:09:50.080 align:middle line:84% been robust, and inflation may well 00:09:50.080 --> 00:09:52.420 align:middle line:84% be stickier than they had previously assumed. 00:09:52.420 --> 00:09:54.640 align:middle line:84% This is reflected in the Fed's updated summary 00:09:54.640 --> 00:09:56.530 align:middle line:84% of economic projections, which show 00:09:56.530 --> 00:09:58.420 align:middle line:84% upward revisions to its inflation estimates 00:09:58.420 --> 00:10:01.210 align:middle line:84% and a reduction in the estimated unemployment rate. 00:10:01.210 --> 00:10:03.340 align:middle line:84% Consequently, the Fed accelerated the pace 00:10:03.340 --> 00:10:06.517 align:middle line:84% of tapering, now proposing to reduce bond purchases by $30 00:10:06.517 --> 00:10:08.350 align:middle line:84% billion per month, with an eye to completing 00:10:08.350 --> 00:10:10.047 align:middle line:90% the process by March. 00:10:10.047 --> 00:10:11.630 align:middle line:84% This should clear the way for increase 00:10:11.630 --> 00:10:13.172 align:middle line:84% in the federal funds rate potentially 00:10:13.172 --> 00:10:14.380 align:middle line:90% starting as early as June. 00:10:14.380 --> 00:10:17.140 align:middle line:84% And the median dot plot of FOMC participants 00:10:17.140 --> 00:10:19.330 align:middle line:84% now suggests the potential for three rate hikes 00:10:19.330 --> 00:10:24.270 align:middle line:84% by the end of 2022 and three further rate hikes in 2023. 00:10:24.270 --> 00:10:26.372 align:middle line:84% So what does all this mean for investors? 00:10:26.372 --> 00:10:28.080 align:middle line:84% For fixed-income investors, the challenge 00:10:28.080 --> 00:10:30.390 align:middle line:84% is that the combination of very easy monetary policy 00:10:30.390 --> 00:10:32.250 align:middle line:84% and a recession has left 10-year Treasury 00:10:32.250 --> 00:10:36.250 align:middle line:84% yields at very low levels, as is shown on page 33. 00:10:36.250 --> 00:10:38.080 align:middle line:84% Despite consistent upside surprises 00:10:38.080 --> 00:10:40.840 align:middle line:84% on measures of wages, home prices, and consumer prices, 00:10:40.840 --> 00:10:43.600 align:middle line:84% long-term rates have held steady at around 1.5%, 00:10:43.600 --> 00:10:47.732 align:middle line:84% after backing up to 1.7% earlier last year. 00:10:47.732 --> 00:10:49.690 align:middle line:84% The liquidity facilities established by the Fed 00:10:49.690 --> 00:10:51.730 align:middle line:84% to protect other parts of the bond market 00:10:51.730 --> 00:10:53.570 align:middle line:84% have tended to compress credit spreads, 00:10:53.570 --> 00:10:55.840 align:middle line:84% while low foreign yields, portfolio rebalancing 00:10:55.840 --> 00:10:58.660 align:middle line:84% into long-term bonds, and a temporary lull 00:10:58.660 --> 00:11:00.730 align:middle line:84% in the supply of Treasuries have all suppressed 00:11:00.730 --> 00:11:02.920 align:middle line:90% long-term interest rates. 00:11:02.920 --> 00:11:05.040 align:middle line:84% However, policy support for the Treasury market 00:11:05.040 --> 00:11:07.567 align:middle line:84% is now fading, and a new, higher debt ceiling 00:11:07.567 --> 00:11:09.900 align:middle line:84% has been approved by Congress, allowing for an increased 00:11:09.900 --> 00:11:12.160 align:middle line:90% supply of Treasuries. 00:11:12.160 --> 00:11:13.780 align:middle line:84% Given this and an economic backdrop 00:11:13.780 --> 00:11:15.850 align:middle line:84% of strong economic growth and high inflation, 00:11:15.850 --> 00:11:18.100 align:middle line:84% we expect long-term interest rates to rise in the year 00:11:18.100 --> 00:11:18.973 align:middle line:90% ahead. 00:11:18.973 --> 00:11:21.640 align:middle line:84% Of course, there continues to be a place in portfolios for fixed 00:11:21.640 --> 00:11:23.920 align:middle line:84% income to provide diversification and protection 00:11:23.920 --> 00:11:26.810 align:middle line:84% in the case of an equity market or economic relapse. 00:11:26.810 --> 00:11:29.260 align:middle line:84% However, given an unfavorable fundamental backdrop 00:11:29.260 --> 00:11:31.720 align:middle line:84% for fixed income generally and tight spreads in credit 00:11:31.720 --> 00:11:34.780 align:middle line:84% markets, investors may want to keep durations relatively short 00:11:34.780 --> 00:11:36.670 align:middle line:84% and limit their exposure to credit risks 00:11:36.670 --> 00:11:38.950 align:middle line:90% within the bond market. 00:11:38.950 --> 00:11:42.610 align:middle line:84% Half the story in any investment analysis is valuations. 00:11:42.610 --> 00:11:45.220 align:middle line:90% And valuations are very high. 00:11:45.220 --> 00:11:47.500 align:middle line:84% On slide 5 of the Guide, we show the PE ratio 00:11:47.500 --> 00:11:49.150 align:middle line:90% over the last 25 years. 00:11:49.150 --> 00:11:51.820 align:middle line:84% The S&P 500 is currently selling at over 21 00:11:51.820 --> 00:11:53.500 align:middle line:84% times forward earnings, which is more 00:11:53.500 --> 00:11:56.620 align:middle line:84% than one standard deviation above its long-term average. 00:11:56.620 --> 00:11:59.500 align:middle line:84% Earnings likely continue to grow in the fourth quarter 2021, 00:11:59.500 --> 00:12:01.900 align:middle line:84% and extrapolating these higher earnings into 2022 00:12:01.900 --> 00:12:04.450 align:middle line:84% could lead to a further compression in these ratios. 00:12:04.450 --> 00:12:06.910 align:middle line:84% Relatively low interest rates likely justify 00:12:06.910 --> 00:12:08.710 align:middle line:84% some elevation of valuation measures 00:12:08.710 --> 00:12:10.395 align:middle line:90% above their historical averages. 00:12:10.395 --> 00:12:11.770 align:middle line:84% However, these interest rates are 00:12:11.770 --> 00:12:13.660 align:middle line:84% likely to rise somewhat in the year ahead, 00:12:13.660 --> 00:12:16.330 align:middle line:84% and slowing economic growth, higher corporate taxes, 00:12:16.330 --> 00:12:18.250 align:middle line:84% and stronger wage pressures could all 00:12:18.250 --> 00:12:19.702 align:middle line:90% impede earnings growth. 00:12:19.702 --> 00:12:21.910 align:middle line:84% Consequently, investors may want to take a sober look 00:12:21.910 --> 00:12:24.640 align:middle line:84% at valuations and recognize the limited potential for gains 00:12:24.640 --> 00:12:28.250 align:middle line:84% in broad US equity indices in the years ahead. 00:12:28.250 --> 00:12:30.200 align:middle line:84% After multiple years of strong outperformance 00:12:30.200 --> 00:12:33.620 align:middle line:84% of growth stocks, most notably during the pandemic in 2020, 00:12:33.620 --> 00:12:36.740 align:middle line:84% value stocks began to recover earlier last year. 00:12:36.740 --> 00:12:38.960 align:middle line:84% However, a combination of declining interest rates, 00:12:38.960 --> 00:12:41.630 align:middle line:84% fears about the Delta variant, and disappointing economic data 00:12:41.630 --> 00:12:43.400 align:middle line:84% relative to expectations led growth 00:12:43.400 --> 00:12:45.980 align:middle line:84% to outperform in the second half of the year. 00:12:45.980 --> 00:12:48.290 align:middle line:84% Does value still have room to run? 00:12:48.290 --> 00:12:51.410 align:middle line:84% Page 10 of the Guide provides some insight into this debate. 00:12:51.410 --> 00:12:53.660 align:middle line:84% The left-hand side shows that value stocks 00:12:53.660 --> 00:12:55.220 align:middle line:84% remain at historically cheap levels 00:12:55.220 --> 00:12:57.830 align:middle line:84% relative to growth stocks compared to long-term averages 00:12:57.830 --> 00:13:00.560 align:middle line:84% and carry substantially higher dividends. 00:13:00.560 --> 00:13:03.110 align:middle line:84% Additionally, value generally tends to outperform growth 00:13:03.110 --> 00:13:05.833 align:middle line:84% during periods of above-trend economic activity and rising 00:13:05.833 --> 00:13:07.250 align:middle line:84% interest rates, such as we project 00:13:07.250 --> 00:13:08.840 align:middle line:90% over the next few months. 00:13:08.840 --> 00:13:10.340 align:middle line:84% This reflects the fact that earnings 00:13:10.340 --> 00:13:11.990 align:middle line:84% of value-oriented sectors tend to be 00:13:11.990 --> 00:13:14.000 align:middle line:84% more sensitive to the pace of economic growth, 00:13:14.000 --> 00:13:16.378 align:middle line:84% as shown on the right-hand side of the chart. 00:13:16.378 --> 00:13:18.920 align:middle line:84% However, investors would be wise not to abandon growth stocks 00:13:18.920 --> 00:13:21.290 align:middle line:84% altogether, as the economy is likely to slow down 00:13:21.290 --> 00:13:24.350 align:middle line:84% to a much slower pace of economic growth later in 2022 00:13:24.350 --> 00:13:26.840 align:middle line:84% and in 2023, and growth stocks have traditionally 00:13:26.840 --> 00:13:29.390 align:middle line:84% outperformed value stocks in a slow economic growth 00:13:29.390 --> 00:13:31.097 align:middle line:90% environment. 00:13:31.097 --> 00:13:33.180 align:middle line:84% Investors may also want to increase their holdings 00:13:33.180 --> 00:13:34.732 align:middle line:90% of international equities. 00:13:34.732 --> 00:13:36.690 align:middle line:84% While the expected synchronized global recovery 00:13:36.690 --> 00:13:38.910 align:middle line:84% has been delayed, it has not been derailed. 00:13:38.910 --> 00:13:40.428 align:middle line:84% And vaccination programs overseas 00:13:40.428 --> 00:13:42.720 align:middle line:84% have made significant progress, with many countries now 00:13:42.720 --> 00:13:44.340 align:middle line:90% outpacing the United States. 00:13:44.340 --> 00:13:46.410 align:middle line:84% In addition, valuations remain attractive, 00:13:46.410 --> 00:13:48.710 align:middle line:84% with both emerging-market and developed-country stocks 00:13:48.710 --> 00:13:50.085 align:middle line:84% outside the United States selling 00:13:50.085 --> 00:13:52.293 align:middle line:84% at some of their cheapest levels relative to their US 00:13:52.293 --> 00:13:54.420 align:middle line:84% counterparts in the last 20 years. 00:13:54.420 --> 00:13:56.890 align:middle line:84% International equities also offer greater sensitivity 00:13:56.890 --> 00:13:59.430 align:middle line:84% to the powerful post-pandemic economic rebound, 00:13:59.430 --> 00:14:02.250 align:middle line:84% particularly Europe and Japan, where cyclical sectors comprise 00:14:02.250 --> 00:14:05.700 align:middle line:84% over half of the respective equity markets. 00:14:05.700 --> 00:14:07.700 align:middle line:84% This, along with structural growth opportunities 00:14:07.700 --> 00:14:09.750 align:middle line:84% and the prospect of lower dollar in the long run, 00:14:09.750 --> 00:14:12.208 align:middle line:84% all argue for greater allocation to international equities, 00:14:12.208 --> 00:14:15.470 align:middle line:84% with a particular focus on Europe and East Asia. 00:14:15.470 --> 00:14:17.960 align:middle line:84% Finally, slide 12 shows the valuation dispersion 00:14:17.960 --> 00:14:20.930 align:middle line:84% of stocks within the S&P 500 over the last 25 years, 00:14:20.930 --> 00:14:22.482 align:middle line:84% illustrating a widening valuation 00:14:22.482 --> 00:14:24.440 align:middle line:84% gap between the most- and least-favorite stocks 00:14:24.440 --> 00:14:26.010 align:middle line:90% in the market. 00:14:26.010 --> 00:14:28.410 align:middle line:84% This current S&P 500 valuation spread 00:14:28.410 --> 00:14:30.780 align:middle line:84% is markedly higher than 25-year average. 00:14:30.780 --> 00:14:32.340 align:middle line:84% This wide dispersion of valuations 00:14:32.340 --> 00:14:35.400 align:middle line:84% points to an opportunity for active management. 00:14:35.400 --> 00:14:37.290 align:middle line:84% The US economy has had a bumpy recovery, 00:14:37.290 --> 00:14:38.790 align:middle line:84% with higher than expected inflation, 00:14:38.790 --> 00:14:41.790 align:middle line:84% but is still on a strong footing as we enter 2022, 00:14:41.790 --> 00:14:44.400 align:middle line:84% and further progress on the pandemic at home and abroad 00:14:44.400 --> 00:14:46.650 align:middle line:84% will continue to be a tailwind for the global economic 00:14:46.650 --> 00:14:47.550 align:middle line:90% recovery. 00:14:47.550 --> 00:14:49.320 align:middle line:84% Given the substantial gains markets 00:14:49.320 --> 00:14:51.360 align:middle line:84% have seen thus far in the economic cycle, 00:14:51.360 --> 00:14:53.850 align:middle line:84% investors would be wise to focus on fundamentals 00:14:53.850 --> 00:14:55.920 align:middle line:84% and maintain a well-diversified stance 00:14:55.920 --> 00:14:58.350 align:middle line:84% as we move forward into a hopefully happier 00:14:58.350 --> 00:15:00.360 align:middle line:90% and much healthier 2022. 00:15:00.360 --> 00:15:04.610 align:middle line:90% [MUSIC PLAYING] 00:15:04.610 --> 00:15:18.000 align:middle line:90%