3rd quarter market review and 4th quarter outlook [PODCAST]
A look back and then a look forward as we move towards year’s end.
A look back and then a look forward as we move towards year’s end.
For the past decade in the global stock market, the best game in town has been the U.S. large cap sector. But as the U.S. market stretches to new highs – and historically high valuations – could international stocks soon begin to make up the lost ground?
“International stocks, especially in the developed markets, have underperformed U.S. stocks since the Great Recession,” explained Noah Monsen, CFA, senior portfolio manager of Thrivent Global Stock Fund (IILGX). “Since about 2010, total return has been about 100% for the international market versus a total return of about 300% for the U.S. market, so there’s a lot of ground to make up. But I think there’s some potential for the foreign markets to start to catch up.”
One key catalyst for the strong performance of the U.S. market has been economic growth, which has significantly outpaced the international area. Much of that growth has been driven by the technology sector, explained Monsen. “Big technology firms have a much bigger presence in the U.S. than foreign markets.”
Adding to the U.S. advantage recently has been its robust roll-out of the COVID-19 vaccine. But as the rest of the world catches up, other markets may see a similar resurgence in their economies.
“Europe has been behind the U.S. in terms of reopening and vaccinations,” explained David Spangler, CFA, senior portfolio manager and head of mixed asset and market strategies, “but they've been catching up.” If Europe’s recovery follows the same pattern as the U.S., that could lead to a similar trend in its equity markets.
“If you think about the U.S. market, after we got the news last November that we may be getting a new vaccine, the markets performed very well,” recalled Spangler. “And then it really accelerated after we got the vaccination approvals and as we ramped up vaccinations in the early part of this year.”
With Europe’s vaccination efforts picking up steam, its stock markets have begun to respond. “As vaccination rates increase – as they have been in Europe – and as mobility increases, we’ve seen increases in both consumer and business confidence,” said Spangler.
Monsen echoed that sentiment: “In the U.S., we’ve already seen a post-pandemic bounce. Now I think there’s probably more potential for a bounce in some of the foreign markets where the economies have been slower to reopen because vaccination rates have been lower than in the U.S.”
Spangler and Monsen noted, however, that the emergence of new COVID-19 variants could result in renewed restrictions across Europe that could short-circuit Europe’s ability to catch up with the U.S.
In the short term, Europe’s anticipated post-pandemic bounce may give its markets an advantage. But the U.S. still has some economic advantages that could provide better long-term potential. “The U.S. has a more dynamic, less regulated economy,” explained Spangler. “The demographics in Europe and across Asia are not as good as they are in the U.S., particularly in terms of working age population and birth rate.”
The biggest long-term advantage, however, may be the strength of the technology sector in the U.S. “The U.S. is a world leader in technology,” said Spangler. “Europe is well behind the U.S., and they’re not likely to catch up. While there is some opportunity in Europe from a reopening standpoint in the near term, we think that over the intermediate and long-term, the U.S. is a better area for investment due to our overall industries and sectors, governance, regulatory climate, and innovation.”
The emerging markets, which have been slower to reopen from the pandemic, did get a boost from the recent spike in commodity prices. “Emerging markets are very sensitive to the commodity cycle,” said Monsen, “so a lot of those markets moved up strongly along with the rise in commodity prices. But that seems to have leveled off.”
The longer-term view for the emerging markets is less promising, according to Spangler. “We have some concerns about the emerging markets on a number of levels. They were great beneficiaries of globalization and outsourcing, but we're now in more of a deglobalization phase.”
Prospects in China, which accounts for about one-third of the MSCI Emerging Markets Index, are also a concern. Spangler pointed out that areas such as governance, transparency and geopolitical issues could adversely affect its economy. “China’s economy has been growing tremendously, but its growth is expected to drop to the 5 - 6% range by 2022,” said Spangler. “China has a demographic issue in terms of the aging of its population, as well as tremendous debt issues, and that tends to have a spillover effect to the rest of the emerging markets.”
“As we’ve moved from recovery to expansion, the question I think the markets are grappling with is where we are in the expansion,” explained Spangler. “Are we in the early, middle or late innings?”
The early stages of recovery often lead to a “junk” rally, with low quality, high beta types of securities leading the market, according to Spangler. “But as you move from recovery to expansion, the focus moves to cyclical value and companies with better earnings quality. Then as you move towards slowdown, the market tends to rotate toward more defensive areas, such as larger cap, utilities, staples and more stable big-cap technology types of companies.”
While the U.S. market has enjoyed strong growth with very little volatility recently, Spangler noted that “under the surface there is a lot of turmoil and a lot of rotation going on.” Inflation and actions by the Federal Reserve (Fed) could influence the direction of the stock market in the months ahead.
“If inflation is indeed transitory, as the Fed says, then we would expect a more risk-tolerant market with leadership from small caps and cyclicals,” said Spangler. “But if the Fed is wrong and inflation exceeds their targets and gains traction, then the market may expect the Fed to taper its bond buying earlier than expected and pull forward rate increases – the proverbial case of the Fed pulling the punch bowl away from the party. Without the monetary support from the Fed, we could see a market correction.”
Facing a variety of potential scenarios, Spangler and Monsen believe the best course forward is to maintain a balanced portfolio. “What we try to do with Thrivent Global Stock Fund is run a nice diversified portfolio of global equities, diversify our managers, diversify our strategies, and position our portfolio at the margin for where we think we are in the economic cycle,” said Spangler. “That's why we are overweight domestic large caps and growth, while within international, we are a little overweight in Europe and a little underweight in the emerging markets.
“We believe we're in the earlier to middle innings of economic expansion,” added Spangler. “But we still see some cause for caution – and that's how we're currently positioned.”
All information and representations herein are as of 07/20/2021, unless otherwise noted.
The views expressed are as of the date given, may change as market or other conditions change, and may differ from views expressed by other Thrivent Asset Management, LLC associates. Actual investment decisions made by Thrivent Asset Management, LLC will not necessarily reflect the views expressed. This information should not be considered investment advice or a recommendation of any particular security, strategy or product. Investment decisions should always be made based on an investor’s specific financial needs, objectives, goals, time horizon, and risk tolerance.