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Allianz Investment Management LLC 2021 Market Outlook

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Market Update: Strong rebound on the horizon

The onset of the global pandemic followed by widespread lockdowns brought the economy to a halt and sent financial markets into a tailspin. The month of March was particularly difficult for risk assets as the equity market’s level 1 circuit breakers were triggered four times, US Treasury yields plummeted to historical lows across the curve, and the Cboe Volatility Index (VIX) – often referred to as the fear gauge – soared to its highest level ever recorded. Fortunately, the Fed and global central banks came to the rescue to stabilize the fallout from the pandemic. Additionally, Congress passed the $2.2 trillion CARES Act and pumped an unprecedented amount of fiscal stimulus into the economy. Despite massive economic headwinds, markets have continued to overcome hurdles of uncertainty along the way. After enduring a global lockdown, a second virus wave, and a highly uncertain presidential election, markets are at all-time highs. However, the economy is facing yet another challenge as virus cases spike heading into the winter months. High frequency data is something we have paid attention to closely during the pandemic and the data is beginning to signal a slowdown in the near term. While the economic outlook is fairly bleak for the coming months, we expect the economy will come out of hibernation from the virus as vaccines are distributed and the second half of 2021 should yield a strong rebound for the global economy.

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COVID-19 implications

The virus is front and center in gauging the near term economic growth prospects. We anticipate an isolated winter as rising cases and hospitalizations will keep pressure on the health care system. We are mindful of the virus’s devastating effects on economic, social, and public health globally. However, with the vaccine effectiveness continuing to look favorable we are anticipating that in early 2021 we will see the spread of the virus slow – both from the vaccine and from a large percentage of the population already having had exposure. We acknowledge the potential challenges for the initial supply rollout and wide acceptance of a first phase vaccine, but believe when faced with a large singular challenge that perseverance and common sense will win out.

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Policy implications from the U.S. election

Although not official, we are aligned with the consensus viewpoint that we will be facing a divided government with Republicans maintaining control of the Senate (runoff election in Georgia for two Senate seats unlikely to both go to the Democrats). This will mean large policy changes will require bipartisan support and will likely be on a lower magnitude or focused on areas with an executive order from President-elect Joe Biden, such as energy, immigration, and trade. While we expect a softer tone in the headlines on the China trade situation, we anticipate a hard line to remain as tougher China trade policies have gained bipartisan support.

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Taxes
Implication: 
Corporate and individual tax hikes unlikely under divided government.
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Fiscal policy
Implication:
Fiscal spending will likely be scaled back under a divided government, but rising virus cases increase the probability of a fiscal bridge until the vaccine is deployed.
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Monetary policy
Implication: 
Lower fiscal spending puts the pressure on monetary policy to remain accommodative and the potential for additional monetary stimulus increases should the conditions warrant it. 
 
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Infrastructure
Implication: 
Bipartisan support for adding jobs to fix aging infrastructure makes this look more possible in 2021.
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Renewable energy
Implication:
Scaled back initiatives under divided government, but still room to tighten fracking on public land, reinstate auto mileage standards scaled back under Trump, increase support for wind/solar projects, and pursue climate-friendly initiatives.
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China trade
Implication:
Likely a softened tone with China, but a hard line is likely to remain as anti-China policies have gained bipartisan support. Unlikely the U.S. will restart TPP, but the U.S. could push to rework other unilateral trade deals.
 
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2021 U.S. Economic and Market Outlook

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U.S. GDP 3.50%-4.50%

There is no doubt the path of the virus will continue to dictate the trajectory of the economy in the near term and rising virus cases heading into the winter months will prove to be a challenging environment for the economy. Restrictions from state and local governments will likely dampen economic activity in the short-run. However, the progress made towards a viable vaccine combined with the likelihood of additional fiscal stimulus to bridge the economic output gap is setting up the economy for a strong rebound in 2H of 2021. Should an effective vaccine take hold in 2021, we suspect consumers will come out of hibernation and economic activity will re-open across all sectors, providing a strong tailwind for GDP in 2021. 

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U.S. Inflation 1.60%-2.10%

Inflation has been a tricky topic for market participants and Fed officials alike in recent years and 2021 likely won’t be any different. The pandemic has caused some damaging effects on specific sectors with demand and prices collapsing during the first lockdown. While we expect demand and prices to rebound in depressed sectors next year, there is little evidence to support overshooting inflation. After all, labor market conditions remain unfavorable for runaway inflation and with unemployment levels remaining elevated, inflation will likely be contained. Overall, we expect inflation, measured by core personal consumption expenditures, to normalize in 2021 and not overshoot.

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U.S. Rates 1.00%-1.50%

Tied closely to the growth rebound in 2021, we are expecting interest rates to follow suit. The increase in rates will mostly be felt by long-duration investors as the Treasury curve continues to steepen in 2021. Fed officials have already signaled that policy rates will be anchored to zero through 2023, so any upward pressure in rates will be most pronounced in the back-end of the curve. Treasury yields will most likely be playing catch-up with the enthusiasm in the rest of the market, but the Fed has the ability to rein in any significant rise in rates by extending the duration of their asset purchases. The last thing Jay Powell is looking for is a repeat of the taper-tantrum in 2013 with long-term rates rising significantly during an economic recovery. Thus, we expect rates to rise moderately with the 10-year Treasury yield moving up to 1.25% by the end of 2021.

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U.S. Equity 10%-15%

Markets will likely remain choppy in the near term as the daily news flow on the virus remains fluid, but we expect this to subside as we get further into 2021. However, we believe that the equity market will remain resilient even during a period that could see an increase in Covid-19 related restrictions as the market looks beyond the bad news and anticipates the better days ahead. With the focus on what is ahead, we can foresee a continued reversal taking place that would benefit the sectors that have been beaten down the most by the virus. While earnings over the last year declined by approximately 6% as of the end of 3Q, if you exclude the Oil, Airlines and Hotel Industries, the S&P 500® year-over-year earnings would be up approximately 4%. The rebound in earnings for depressed sectors will lift equity indices in 2021. With earnings growth in the range of 20%-30%, it would not be a stretch to see the S&P 500 equity index return 10%-15% in 2021. While we remain optimistic, we are also mindful that a continued rally into the end of 2020 could reduce return prospects in 2021, and with equities at all-time highs, this could pose a risk for a pullback early in the new year.
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Conclusion

In conclusion, we are eager to close the chapter on 2020 and have reason for optimism in the new year as it looks increasingly promising for vaccines and herd immunity to suppress the virus. With the U.S. election resulting in a divided government we anticipate only modest policy changes with the new administration. The Fed is likely to remain accommodative on monetary policy keeping short-term interest rates low throughout 2021. These factors should combine to provide a favorable backdrop for the continued economic recovery and prove supportive for the reflation of growth and risk assets in 2021.

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The views expressed above reflect the views of Allianz Investment Management LLC, as of 12/2020. These views may change as market or other conditions change. This report is not intended and should not be used to provide financial advice and does not address or account for an individual's circumstances. Past performance does not guarantee future results and no forecast should be considered a guarantee either. Allianz Investment Management LLC is a registered investment adviser that is a wholly owned subsidiary of Allianz Life Insurance Company of North America.