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OUR VIEW

A look ahead: Fourth quarter 2021 outlook

10/12/2021

What are some key factors influencing the economy and markets in the coming months?

Fed policy and inflation

The Federal Reserve (Fed) has kept short-term rates near zero and purchased large quantities of bonds to help boost financial markets.

However, they’ve indicated a coming tapering to bond purchases and may be seeing some personnel turnover that could lead to increased uncertainty about Fed policy.

Furthermore, the Fed has been debating whether their earlier position that high inflation is “transitory” due to the impacts of supply chain bottlenecks still holds true.

While we expect monetary support to continue for financial markets, the entire investment industry will be watching Fed policy very closely in coming months.

Supply/demand dynamics

Consumer demand is strong and the labor market is tight, which is a double-edged sword for the economy: increasing income and wages is bolstering demand, but the pandemic and demographic trends is hindering the labor supply.

Additionally, the pandemic continues to impact global supply chains, leading to a number of shortages, while geopolitical issues (generally regarding China) have also hindered the sourcing of supplies.

All of that leads to rising prices, which could eventually negatively impact corporate earnings.

Market outloook

Key supports to the economy and markets remain in place, but cost pressures, monetary policy uncertainty, and fiscal policy politics present new challenges for investors to consider.

With interest rates below inflation, fixed-income returns will likely be lackluster, but we don’t see a rapid rise in interest rates any time soon.

We still prefer equities, but with high valuations on top of the other challenges we’ve outlined, we continue to believe this is not a time for aggressive positioning.

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Asset allocation views: Current outlook

Tactical vs. strategic position

Equity vs. Fixed Income

Equity markets have done reasonably well this year while U.S. economic data remains strong, despite challenges from the emergence of the COVID-19 delta variant.

On the fixed-income side, Treasury yields have declined, the yield curve has flattened and credit spreads are well below average levels, all of which limit the upside for returns.

Putting those factors together, we are maintaining a roughly neutral positioning against strategy and a slight equity overweight versus peers.

Equities

U.S. vs. Int'l.

We continue to favor U.S. markets vs international ones, but are tilted more to Europe within international to increase exposure to cyclical stocks, which helps diversify the U.S. positioning that leans more toward defensive areas of the market like growth and tech stocks.

Europe has the potential to provide relative outperformance as the delta variant begins to recede, too.

We still prefer developed international over emerging markets, which have performed poorly so far this year largely due to China, which makes up roughly one third of the MSCI Emerging Markets index and has challenges ahead such as a rapidly aging population, a material debt burden and rising geopolitical tensions.

Market Cap

We remain overweight large and mid-caps but have increased small caps closer to neutral from a prior underweight.

Defensive areas like large cap growth and tech stocks noticeably outperformed more cyclical areas like small cap in the third quarter.

However, economic conditions remain strong, which should lead to better performance from areas like small cap as the threats from the delta variant begin to recede.

Fixed-income

Duration

Interest rates fell again in the beginning of the quarter before rising back to close to where they started by the end of the quarter.

We were generally short duration during the quarter, but have moved to a more neutral positioning as the Fed’s plan to start tapering gets closer and we begin to learn more about the nature of the current inflation.

Yield Curve

The yield curve flattened sharply during the second quarter with long-term rates falling and short-term rates rising; the third quarter saw modest flattening until the very end when long-term rates increased more than short-term rates, thus steepening the curve.

This was driven in part to expectation that the Fed will commence its tapering of Treasury and mortgage-backed securities, which would increase market supply of these securities.

We expect to be looking for opportunities to exit curve flattening strategies and enter curve steepening strategies.

Credit Quality¹

Credit spreads declined again in the third quarter, falling far below long-term averages.

We expect credit spreads to stay relatively range-bound with some slight tightening; however, the low spread levels make corporate credit more susceptible to backups on negative news.

High-quality credit, though, continues to offer little absolute yield and remains sensitive to interest rate increases, so we continue to modestly prefer lower quality sectors, like high yield and leveraged loans.

We also favor selectively seeking yield in alternative fixed-income sectors, such as preferred securities and fixed-income closed-end funds.

¹ Credit Quality ratings are determined by credit rating agencies Moody’s Investor Services, Inc. or Standard & Poor’s Financial Services, LLC.

The Senior Investment Team is discussing the asset classes, sectors and portfolios they oversee at a macroeconomic level. The views expressed are as of the date given unless otherwise noted and 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 recommendations of any particular security, strategy or product.

Past performance is not necessarily indicative of future results.