Q3 2021

Investment Outlook

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July 2021

Staying Mindful of Complacency

By Victor Zhang

When we think the wind is at our backs, it’s easy to overlook the risks around us. This tendency is attributable to recency bias, a well-researched behavioral inclination to place greater importance on our most recent experiences.

From an investment perspective, recency bias can cause underconfidence or overconfidence in response to the most recent market events. Think about how far we’ve come since the market hit its pandemic lows. Economies are reopening as vaccine distribution gains momentum.

Global economic and earnings growth are picking up steam thanks to aggressive fiscal stimulus, accommodative monetary policy and pent-up demand. It’s easy to see why the Conference Board’s most recent survey of multinational CEOs indicated the highest level of CEO confidence in the survey’s 44-year history.1

Are We Underestimating the Risks We’re Taking?

We think there’s a lot to be optimistic about, but it’s sensible to ask whether this confidence has led us to underappreciate emerging risks in the market. As we’ver learned yet again over the last 18 months, markets are dynamic and economic conditions can change quickly.

That’s why we think it’s vital to challenge assumptions. As you’ll read in this issue of Investment Outlook, our chief investment officers generally agree with the Federal Reserve’s view that the current uptick in inflation is transitory. Even so, however, our entire investment team recently met to discuss the downside of being wrong.

Demand-driven inflation is possible given the high level of federal spending while the Fed is holding rates near zero. We’re also seeing rising housing prices due to high demand coupled with a tight supply of existing homes and rising costs for new construction. And, with labor shortages in some sectors of the economy, wage inflation could be a threat if employers hike pay to attract workers.

We’re Monitoring Possible Blind Spots About Inflation Assumptions

We’ve also considered the possibility the Fed is underestimating the recovery in the “informal” job market. The Bureau of Labor Statistics estimates this segment of the market, which operates on a cash basis, accounts for 17% of the U.S. population. These jobs produce income that puts upward pressure on inflation, but payroll data doesn’t reflect them.

While this potential blind spot doesn’t change our view, it does remind us of the risk surrounding inflation assumptions. Investors could be set up for an unpleasant policy surprise if these assumptions are wrong and the Fed must move faster and more aggressively than expected to cool down an overheated economy.

We’re Optimistic About Economic Recovery but Expect Volatility

Overall, the global economy is healthy and corporate earnings are on a trajectory to reach pre-pandemic levels later this year or in early 2022. Still, we see the risk of higher inflation and interest rates as potential sources of volatility. And, after a year of stock prices rising in anticipation of a profit recovery, investor expectations are high, leaving companies with little room to disappoint.

Committing to a long-term strategy to meet your financial goals helps overcome recency bias. Has your portfolio been rebalanced after the terrific rise in equities? Should you consider deploying inflation-protected fixed income strategies or short duration multi-sector fixed income strategies?

The best time to adjust portfolios is when markets are calm. We think it’s a good time to reevaluate portfolios before volatility returns.

Thank you for investing with us.



1“Measure of CEO Confidence™,” The Conference Board, May 19, 2021.



Key Takeaways

The global economy is healthy, and profits are rebounding, but we caution against underestimating market risk. Volatility could spike if investors’ assumptions about inflation, interest rates and corporate earnings are wrong.


The U.S. is leading the recovery in developed markets as easing coronavirus restrictions unleash pent-up consumer demand. The outlook for emerging markets is improving as vaccination rates climb.

 

We agree with the U.S. Federal Reserve’s (Fed’s) view that much of the upward pressure on inflation is transitory due to higher demand and disrupted supply chains. But we believe services inflation will continue upward and keep inflation elevated.

 

Our outlook for emerging markets sovereign debt, U.S. securitized and municipal bonds is positive. We’re more selective around U.S. credit, U.S. government and European debt.

 

Following the broad cyclical upswing, we expect the market to become more discerning, making company-specific data a more important performance driver.

 

We view the global shortage of semiconductors that’s disrupting numerous industries as temporary. Longer-term, we believe governmental support for expanding production capacity is beneficial for companies that make chip manufacturing equipment.


Q3 2021 Investment Outlook Resources

References to specific securities are for illustrative purposes only, and are not intended as recommendations to purchase or sell securities. Opinions and estimates offered constitute our judgment and, along with other portfolio data, are subject to change without notice.

International investing involves special risk considerations, including economic and political conditions, inflation rates and currency fluctuations.

Investment return and principal value of security investments will fluctuate. The value at the time of redemption may be more or less than the original cost. Past performance is no guarantee of future results.

Historically, small- and/or mid-cap stocks have been more volatile than the stock of larger, more-established companies. Smaller companies may have limited resources, product lines and markets, and their securities may trade less frequently and in more limited volumes than the securities of larger companies.

Diversification does not assure a profit nor does it protect against loss of principal.

Generally, as interest rates rise, bond prices fall. The opposite is true when interest rates decline.

Past performance is no guarantee of future results. Investment returns will fluctuate and it is possible to lose money.

The opinions expressed are those of American Century Investments (or the portfolio manager) and are no guarantee of the future performance of any American Century Investments' portfolio. This material has been prepared for educational purposes only. It is not intended to provide, and should not be relied upon for, investment, accounting, legal or tax advice.

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