Rates of change in economic data may be hitting their peaks, but that need not preclude more long-term upside for risky assets.

The S&P 500 and MSCI World Indices are up more than 80% since last March, and market participants are increasingly talking about “peak growth” or “peak PMIs”—the idea that the rates of change in key economic data are likely to plateau and decline over the coming weeks.

We think this may be why investors have hit the pause button on the key recovery trends of the first quarter: the sell-off in U.S. Treasuries and the rotation from large growth stocks into smaller, cyclical and value stocks.

Pausing for breath and rebalancing portfolios, where necessary, seems prudent to us at a time like this. Ultimately, however, we think these trends have further to run, albeit with potentially continued volatility.

Rapid Recovery

It’s true that it would be hard to sustain current levels of economic expansion. The U.S. economy is estimated to have grown at an annualized rate of 6.4% in the first quarter of this year, following 33.4% and 4.3% prints for the last two quarters of 2020. The Markit Composite Purchasing Managers’ Index (PMI) for the U.S. is now at 62.2, its fastest pace of expansion since the survey began in 2009.

As Goldman Sachs has pointed out, over the past 50 years, the peak in PMIs has been followed by one-, three-, six- and 12-month global equity returns that were negative more often than not, and on average close to zero.

But we think history, and particularly historical averages, are a poor guide to what’s going on now. In some of those periods, returns were not only positive, but in double digits. We believe the odds are tilted to the upside this time around for two reasons.

First, there is the sheer extremity of last year’s recession and the low base it set for this year’s economic data. Looking at absolute values rather than growth rates, we see a rapid recovery from an unusual disruption—not the sort of late-cycle exuberance that would be a cue to ease away from risky exposures.

Second, support for the recovery is unprecedented. It comes in the form of high levels of savings and pent-up consumer demand, fiscal stimulus plans on both sides of the Atlantic that are groundbreaking in their size and scope, and central banks that are willing to let economies run hotter than usual before tightening monetary policy.

A Long Journey With a Lot of Stops

We think this weakens the “peak PMI” case against risky assets—with some important nuances.

We expect this cycle to be more inflationary than the previous two or three. As well as favoring smaller companies and more cyclical stocks, we therefore favor a tilt to real asset exposure, whether through commodities, real estate or equities linked to those sectors.

We also continue to look toward non-U.S. equity markets, where year-over-year economic growth statistics have lagged the U.S. but have the potential to inflect higher, where there is generally more cyclical exposure to be had, and where big changes to corporate taxation and regulation appear less likely.

And finally, volatility is likely to persist, precisely due to uncertainty around “peak growth,” the path of inflation, current market valuations, the future tax implications of today’s fiscal policies and even the robustness of the recovery itself. The S&P 500 is near record levels, but so are global new coronavirus infections, driven by a dire situation in India.

As such, while we remain positive on risky exposures on a 12- to 18-month horizon, we are somewhat more cautious in our view for the next three to six months. There are plenty of potential catalysts for retrenchment right now, which could offer opportunities to lean back into the recovery at more attractive levels.

The summit of “peak growth” is a good place to pause for breath and rebalance portfolios, where necessary. We may need to descend a little from here, but ultimately, we believe there will be higher market peaks to climb.

Erik Knutzen, Chief Investment Officer—Multi-Asset Class
May 3, 2021