For the past 15 months, global financial markets have been influenced primarily by generous government programs and historically low interest rates. These measures were designed to mitigate the negative economic and social consequences of the global pandemic. As worldwide vaccination rates climb and the developed economies return to a more normal state, we expect that capital markets will revert to their more traditional behavioural patterns. Chief among them, general angst and volatility as market participants weigh the prospects of future earnings growth against that of rising interest rates.
As the global economic recovery continues to unfold, we foresee a cyclical rise in interest rates. In light of recent inflationary pressures, the market consensus is that the benchmark ten-year US government bond yield will rise from current levels to in and around 2%. This is almost assured by the US Federal Reserve dialing back the emergency measures implemented during the crisis – the exact speed and timing of which can be the only question. As a result, portfolio returns for the overall fixed income allocation will likely remain negative for 2021.
The near-term future for equities, however, we believe is brighter. The global economic recovery will continue to be a potent catalyst for higher corporate earnings in the second half of the year. Equities as an asset class will benefit from this growth. With major global equity indices trading at, or near, all-time record highs, it is argued that much of the good news may already be reflected in current valuations. Nevertheless, we believe expected higher dividend payouts and sizeable share buy-backs will keep the spotlight on equities, thereby justifying a continued overweight in this asset class relative to the benchmark.
For the balance of the year, our objective will be to preserve and where possible add to the attractive portfolio gains that have been achieved so far. Inherent in this is our belief that the vast majority of overall portfolio returns have been seen for the year. Our focus will be on risk management and will be achieved through timely portfolio rebalancing and a greater emphasis on managing duration, credit and foreign exchange risk in the fixed income allocation. Unfortunately, the second half of the year will most likely be characterized by treading water.
We wish you and your families a safe and happy summer season!