These days, many of us are celebrating the return to normalcy following the last 12+ months of pandemic life.
From an economic perspective, a full recovery likely won’t be linear, given recent virus outbreaks in various places and some disruptions in the distribution of the COVID-19 vaccine. Still, many economic and investing experts believe that we are approaching what could be one of the strongest global economic recoveries since the period following World War II.
Many economists say that the impending recovery should accelerate economic growth, boost interest rates, and increase inflation. Looking back through time, these three factors are closely correlated…and have had significant effects on asset classes across the board.
Here, we’ll look at three major asset types and how the recovery might affect them.
What happens to stocks when economic growth accelerates?
Robust vaccine distribution should result in a return to pre-COVID-19 levels of economic activity, as business and consumer demand ramps up and the Federal Reserve keeps the money supply high. Higher interest rates and inflation could present challenges for stocks—depending on sector, industry, and geography.
Within global stock markets, some financial experts believe accelerated economic growth will likely mean that:
- Cyclical sectors and industries may perform better than less cyclical sectors and industries
- Smaller companies may perform better than larger companies (especially major technology companies that outperformed not just last year, but in the last decade)
- Non-U.S. stocks may perform better than U.S. stocks
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What happens to bonds when interest rates rise?
Booming economic growth and rising inflation should push interest rates higher. If this happens, it will have important implications for the bond markets (rising interest rates push down existing bond prices), with higher-quality, longer-duration securities getting hit the hardest. In fact, during the first quarter of 2021, something similar happened: the prices of long-term government bonds faltered when interest rates rose, while riskier bonds (such as high yield) performed well in comparison.
This scenario could play out again, as long as bond issuer defaults do not increase significantly. Floating-rate securities, which consist of bank loans and consumer credit and are less sensitive to rising interest rates, could outperform—again, only if bond defaults remain low.
Many economists believe that, despite rising interest rates, bond returns should remain positive.
How does rising inflation affect inflation-sensitive assets?
High (or rising) inflation—the overall increase in the prices of goods and services over time—can hurt a poorly diversified portfolio.
Inflation has remained low since the 1980s, which has boosted the performance of simple stock-and-bond portfolios. A shift toward higher inflation could cause trouble for them.
Some economists think that inflation will rise sharply in the short term (due to year-over-year comparisons to sharp price declines at the start of the pandemic and the resulting unresolved supply-chain disruptions), while only modestly increasing over the long term (due to robust economic growth and supportive fiscal and monetary policies).
To offset inflation risk, many investors maintain some exposure to inflation-favored assets, such as commodities, inflation-linked bonds, and specialized equity portfolios.
What does all this mean for you?
As life slowly returns to its pre-pandemic routine, now is a great time to re-evaluate your investment portfolio to make sure it is positioned to benefit from the changes that may be coming as the world normalizes.
If you’re looking for a second opinion on your investments, help is just one click away! To schedule a no-cost, no-obligation review of your financial plan with one of our financial advisors, click here.