Due to the large moves up and down in economic data in 2020 caused by the shutdown of activity, it is challenging to determine the expected path of the rate of change in economic activity because the comparison set is so unusual. The rate of change in economic growth and inflation rates has important implications for asset price movements and portfolio positioning. In the current environment, we think it will be most helpful to monitor the market signals to understand what type of economic environment is being priced into various assets.
We have noted in recent posts that our current viewpoint from the market signals of the last few months is that the rate of change in economic growth is slowing (moving back to prior levels) and the rate of change in inflation could increase or be flat at higher absolute levels than prior to 2020.
If the outlook were to change (rate of change in economic growth were to increase, or rate of change in inflation were to decrease), it should be noticeable across various asset classes.
If the rate of change in economic growth is expected to increase, 10-year Treasury yields should increase back towards the 1.7% recent high, the 2–10-year curve should steepen, and high yield spreads should tighten back towards their recent lows.
If the rate of change in inflation is expected to start decreasing along with the rate of change in economic growth, 10-year Treasury yields should decline back towards 1%, 2-year Treasury yields should decline back towards 0%, and high yield spreads should widen to 500-600bps+.
On the equity side, if the rate of change in economic growth is expected to increase, small caps should retake leadership and make new highs, cyclical industries like banks, materials, industrials, and energy should retake leadership and make new highs, utilities should underperform, and lower quality/higher beta factors should outperform.
If the rate of change in inflation is expected to start decreasing along with the rate of change in economic growth, stock indices would stop making new highs and likely enter a bear market (decline 20%+), defensive industries like utilities and staples would likely outperform, higher quality/lower beta would likely outperform, and equity volatility (VIX) would likely increase to above 30.
Commodities would continue to make new highs and oil volatility would likely remain below 40 if the rate of change in economic growth were expected to increase.
If the rate of change in inflation is expected to start decreasing along with the rate of change in economic growth, commodities would stop making new highs and likely decline significantly and oil volatility would likely spike well above 40.
Until the economic data returns to more normalized levels, the most informative way to determine the most likely economic environment will be to monitor cross asset class market signals and expectations in their prices.
The views expressed herein are presented for informational purposes only and are not intended as a recommendation to invest in any particular asset class or security or as a promise of future performance. The information, opinions, and views contained herein are current only as of the date hereof and are subject to change at any time without prior notice.
Senior Vice President, Investment Strategy
Boyd Watterson Asset Management, LLC