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Principal Global Investors

Economic Insights: Recovery is off the boil
Update for the month of December 2020
Commentary by Robert F. Baur, Ph.D., executive director, chief global economist
The phenomenal third quarter economic rebound in the Euro
area and the United States has come off the boil. The giant
surge in new Covid-19 cases across most of Europe may leadto a mild contraction in fourth quarter gross domestic product(GDP). U.S. growth this quarter is mostly set, but a similar floodof recent cases may dent growth early next year.
Widespread use of a new vaccine should bring a robust revival
by spring. Recovery in China nears completion, but Japan isprogressing only slowly.
Stock markets are giddy with optimism but should have amoderate upside in 2021. Beware the potential for year-end
profit-taking.

A November to remember
Try to remember the kind of November
With markets surging and hearts a-twitter.
Try to remember the times in November
Investors were thrilled and eyes a-glitter.
Try to remember the days in November
When prices soaring, no one a quitter.
Try to remember and if you remember,Then wonder, wonder.
Deep in December, it’s nice to remember
The times in November with prices rushing.
Deep in December we all should remember
The fire of November with profits gushing.
Deep in December, we’ll have to remember
And wonder, wonder, wonder.
Apologies to Harvey Schmidt and Tom Jones who wrote thebeautiful song Try to Remember, for the musical comedy
The Fantasticks in 1960. But investors have had infinitely few
months like the one just past. They must remember this one andwonder if another month will ever grace their portfolios so well.
The Dow Jones Industrials Index jumped 11.8%, the best monthly
return since January 1987. The Russell 2000 small cap index
rocketed 18.3% for the hugest monthly gain since records began
in 1978. The uptrend was broad-based with few indices postingnegative returns.
Bond investors had their own parade as well. Credit spreads(the difference between corporate bond yields and yields on
U.S. treasury bonds of similar maturities) narrowed during themonth, offering good returns to owners of most corporate bonds.
Yields on long-term U.S. treasury bonds were about flat for themonth, so even major indices of U.S. government bonds had
decent gains.
Can these gains be justified and prolonged? We think so, at least
for a while.

Rising cases, slowing activity
The global economy continues to claw its way back from the worst
contraction in eight decades even as the pandemic is trying hardto maintain its iron grip. Another wave of COVID-19 infections isundermining the recovery in many northern hemisphere countries.
Russia has hit a new record seven-day moving average of bothdaily new cases and fatalities every day since mid-October. Euroarea countries began to see a big spike in cases in late September.
Fortunately, the average of new daily cases appears to have peakedin mid-November in Italy, Spain, France, Germany, and Austria. NewU.S. infections began to surge in early October but the acceleration
seems to have crested about ten days ago. Even Japan and South
Korea, where contagion has been mostly contained, are seeing fastrising case counts from very low levels.
Despite the second or third wave of infection, the recovery fromthe lockdown recession is motoring on. China’s aggressive “first-in,first-out” expansion remains a key driver of global revival. Whenthe data comes in for this quarter, China’s GDP will likely have hit a
new all-time high, an achievement no other major country will haveattained. China’s goods-producing sector led the way during therebound, spurred by sizeable fiscal stimulus in the form of tax cuts,
lower interest rates, easier lending, rebates on export taxes, andlower pension and insurance payments. Exports were boosted at
first by foreign demand for pandemic-related equipment. Industrial
output continued to surge in October, up 6.9% over the prior year,
improving from 5.6% in August and 1.1% in March. Industrial
profits have come roaring back.
China’s recovery broadened to include services as households
gradually became less restrained. Retail momentum picked up
in October; sales were 4.3% over last year, with auto unit sales
jumping 12.6%. House prices are robust, up 4.3% year-over-year inOctober and residential housing starts up 4.5%. Total real estate
investment bounced 12.7% over the prior October, the best since
July 2018.
China’s recovery and indeed its fast growth in recent years wereboosted at least in part by a significant rise in debt. The downsideis that what’s borrowed must be eventually repaid. Credit spreads
in China have widened recently, according to a recent Bloomberg
article, likely due to a spate of corporate defaults by local stateowned enterprises. Very high debt levels suggest that such fast
growth won’t be sustainable past the intermediate term.
The flood of new virus cases in greater Europe has been followed
by fresh restrictions on economic activity. Falling mobility indices
imply the constraints will hamper growth. Surveys of service sectorbusinesses show a broad contraction as the November Markit
News index fell to 41.3, well below the break-even level, from 48.0
in September. The supply side of the economy is still advancing
with the index for manufacturers at 53.6, 1.2 points lower, but

Expressions of opinions and predictions are accurate as of the date of this communication and are subject to change without notice.
There is no assurance that such events or prospections will occur and actual conditions may be significantly different than that shown here.

still showing expansion. GDP may contract this quarter from lessconsumer activity, but the potential for a vaccine early next year andthe promise of warmer weather portends well for a robust revival by
the second quarter.
Revitalization is in process in Japan, but it’s taking the slow train,
which might, of course, make it more sustainable. With China adriving force in Asia, Japan’s October real exports are jumping, up
4.5% from September, the fifth straight monthly gain. Third quarter
GDP leapt a crisp 21.4% annualized over the prior period, driven by
a 12.1 percentage point gain from net trade as imports plunged.
Domestic demand has stayed weak but shows promise. Services
spending likely rose in October; mobility indices are trending up;
business sentiment is improving for large and small firms; industrial
output is up four months in a row; and third quarter private coremachinery orders have quit falling, up 0.2% in the third quarter
from the second. We look for recovery in the world’s fourth largest
economic area to advance steadily through 2021.
The daily new records in COVID-19 cases, fatalities, andhospitalizations have surely knocked the U.S. rebound off themind-bending pace of the second quarter. Still, the rebound keeps
rolling and recent data show a robust uptrend in October. Shipmentsof real nondefense capital goods ex aircraft are the highest since2015. Economy-wide profits from the National Income andProduct Accounts hit a new all-time high in the third quarter. Newand existing home sales are the best since 2006. Surveys of U.S.
purchasing managers are running hot. The National Association ofHome Builders confidence index hit new consecutive record highs
the last three months. The American Staffing Association indexof temporary help payrolls keeps improving. Job growth has been
exceptional, with more than 2.2 million jobs added in the Octoberhousehold survey.
Mobility indices, OpenTable reservations, and TSA travel counts didtick down in November, as has consumer spending estimated by JP
Morgan Chase credit card data and tracktherecovery.org. Still, there
are reasons to believe healthy momentum will persist.
• Inventories are very low. Rebuilding will add to growth.
• Household formation is rising fast. Mortgage rates stay at
all-time lows. House prices are surging. All will keep housing
activity booming.
• Net exports have subtracted from growth as imports vaulted,
while exports stayed low. U.S. exports will add to growth whenother countries rebound.
• Capital spending will stay vigorous as companies strive to cut costs
and increase productivity.
• Job growth has been excellent. Rising total income from new jobs
and a still-high savings rate imply consumers have funds aplenty tokeep purchasing.

We expect U.S. GDP to rise in the 5% to 8% range annualized thisquarter, as much of the growth has already occurred. The recent rashof virus activity could spill over to slow growth in next year’s firstquarter. After that, we’d expect the vaccine’s arrival to bring a coupleof quarters of 4% to 5% growth in GDP reaching a new high at theend of 2021.

Looking ahead
The astounding resurgence in third quarter growth, and theoptimism displayed in bond and stock markets since the spring, isowed in large part to substantial fiscal spending combined withaggressive monetary policy all over the world. U.S. authorities
boosted fiscal spending by trillions of dollars and the Federal
Reserve (Fed) put generous funds to work backstopping bondmarkets. The European Central Bank deployed new resources tokeep lending channels open and the European Union (EU) had plans
to implement a €750 billion package of loans and grants to member
countries to salve the crisis wounds. Commensurate action has
occurred in most countries.
The question is what happens next. Regardless of the outcome of theGeorgia Senate elections, we expect a phase four stimulus package
to be enacted by January. The $455 billion requested by Treasury
Secretary Mnuchin to be returned by the Fed may be used as part ofthat package to make the next bill palatable to Senate Republicans.
There’s a trickier problem in Europe: Poland and Hungary vetoed
the €750 billion recovery fund, perhaps to gain leverage over a newmechanism that could inhibit funds from flowing to certain member
countries. Since both countries stand to gain from EU disbursements,
the conflict may dissipate eventually. However, that may slow thedelivery of recovery funds and delay the recovery.
It’s possible the global recovery may languish over the winter fromthe flood of new COVID-19 cases. Nevertheless, solid growth should
reemerge with good momentum by spring. It appears at least oneof the new vaccines will become widely available and the world
economy will steadily return to some sort of normal. It will surely bea changed economy after the tumult, isolation, and forced innovationin response to the extraordinary pandemic shock.
We’ll all spend the next couple of years trying to understand what
the long-term New Normal actually entails.

Financial market outlook
Looking ahead, it’s very important to distinguish between anintermediate time frame of six to twelve months versus a much
longer period—such as the rest of this decade. This analyst has beensuggesting for months that the long-term investment climate will bemuch different from what we’ll experience in 2021 or early 2022.
After a fabulous rally in November and indeed since the low inMarch, it’s possible that December could see significant year-end
profit-taking. With a vaccine likely on the way, corporate profits risingswiftly, the global recovery still rolling along, interest rates at superlow levels, and plenty of stimulus still in the pipeline, stock markets
should have some modest upside into mid-2021 or beyond.
The upturn from here will probably be limited because equity
investors are already giddy with enthusiasm and U.S. stock markets
are very highly valued. Put/call ratios suggest investors have little
fear of a downdraft. Price-earnings ratios are at or near the peaks ofprevious bull market tops. Still, the S&P 500 Index should be able toreach the 4000 level by next summer.
Pandemic uncertainty, vast central bank backstops, andgovernment largesse set the perfect environment for the enormous
outperformance of tech and growth stocks. But it does appear
that the huge valuation divergence between growth and value has

Expressions of opinions and predictions are accurate as of the date of this communication and are subject to change without notice.
There is no assurance that such events or prospections will occur and actual conditions may be significantly different than that shown here.

peaked. A vaccine promoting a return to normal will make agood climate for small cap and emerging market stocks, as well as
sectors like materials, energy, industrials, and financials. Any yearend
profit-taking correction might be a good time to rebalance portfolios
away from an overweight to growth and tech. With the U.S. dollar
likely to weaken further, emerging market equities would be theprimary beneficiary.

For bond investors, central banks will keep short rates pegged very
low for a year or two. Yields on long-term safe-haven bonds shouldsee some mild upward pressure next year and into 2022. We’d keep
maturities in the two- to four-year range and stay up in quality in the
non-traditional fixed-income space, using emerging market, highyield or municipal bonds, or preferred securities. It’s still time to avoid
long-term government bonds.

This material covers general information only and does not take account of any investor’s investment objectives or financial situation and should not be
construed as specific investment advice, a recommendation, or be relied on in any way as a guarantee, promise, forecast, or prediction of future events
regarding an investment or the markets in general. The opinions and predictions expressed are subject to change without prior notice. The information
presented has been derived from sources believed to be accurate; however, we do not independently verify or guarantee its accuracy or validity. Anyreference to a specific investment or security does not constitute a recommendation to buy, sell, or hold such investment or security, nor an indication thatthe investment manager or its affiliates has recommended a specific security for any client account. Subject to any contrary provisions of applicable law, theinvestment manager and its affiliates, and their officers, directors, employees, agents, disclaim any express or implied warranty of reliability or accuracy andany responsibility arising in any way (including by reason of negligence) for errors or omissions in the information or data provided.
This material may contain "forward-looking" information that is not purely historical in nature and may include, among other things, projections andforecasts. There is no guarantee that any forecasts made will come to pass. Reliance upon information in this material is at the sole discretion of the reader.
Investing involves risk including possible loss of principal. Past performance is no guarantee of future results. This material is not intended for distribution toor use by any person or entity in any jurisdiction or country where such distribution or use would be contrary to local law or regulation

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MM9908-99 | 12/2020 | 1432570-122021

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