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Principal Global Investors

Economic Insights: A stalling rebound?
Update for the month of November 2020
Commentary by Robert F. Baur, Ph.D., executive director, chief global economist
The surge in daily new Covid-19 cases in Europe is stunting therecovery, but manufacturing there is strong. Even as virus casesin the United States rise, the rebound is extending, and theenergy continues.
The U.S. and Chinese economies are driving the world revival.
October equity market corrections aren’t new to investors, but
this one felt vicious. The potential for a contested U.S. election
could keep volatility high through year-end, but we expect amodest uptrend to materialize in the New Year.
Long-term interest rates could have a mild upside if economic
renewal endures.

Arrive, revive, take five
The mindboggling rebound from the wreckage of the COVID-19
lockdown arrived in the third quarter. In the Eurozone, real
gross domestic product (GDP) grew at a skyrocketing 61.1%
annualized pace from the second quarter. U.S. GDP leapt by anearly as astonishing 33.1% annualized, even with no inventory
gain and a three-percentage-point deduct from net exports. The
U.S. economic revival continues apace with healthy momentum
into November. China’s resurgence remains vigorous as the first
country to show an annual gain in GDP.
After the supercharged economic blastoff of the last quarter,
recovery in the Eurozone could “take five” this quarter, as amild contraction may occur given the surge in COVID-19
cases and renewed restrictions on economic activity. The
seven-day moving average of daily new virus cases is more than
20,000 in Italy and Spain, more than 40,000 in France, and at newrecords in most Euro-area countries and the United Kingdom(here). Fortunately, fatality numbers are staying well below thehigh levels of March and April. Renewed restrictions on many
service-sector businesses will take their toll on growth, butthere are big differences between sectors. October surveys of
manufacturing companies rose nearly a point to 54.4, the highest
since August 2018, while those from service businesses still
indicate contraction.
Rising risks induced the European Central Bank to signal moreeasing action in December to keep financial conditions favorable.
This would likely be increased bond purchases and larger
targeted lending operations to keep plenty of financing available
to business. We also expect Euro authorities to turn a blind eye
to mushrooming fiscal deficits across many countries. In similaraction, the U.K. support programs have already been extended.
We look for a mild contraction in fourth quarter GDP, but arenewed recovery in 2021. Households still have the wherewithal
to spend as U.K. and Eurozone retail sales are already well above
pre-pandemic levels. As Asia gets back to normal, Europe will
benefit from robust foreign demand.

The outlook may have brightened somewhat for Japan. New
infections haven’t risen recently as they have in the U.S. andEurope (here) and daily fatalities stay in single digits. Most of theremaining restrictions on activity were eased in September. Retailsales have recovered almost all the ground lost during April andMay. Industrial production jumped 4.0% in September, the fourthconsecutive gain, and manufacturers expect a sustained recovery.
Exports are gaining momentum given the strong rebound in
China and other parts of Asia. Surveys of purchasing managers
improved a bit in October but show only limited healing. The
government plans to extend its subsidy program for travel
expenses and restaurant payments. We expect Japan’s gradual
recovery to continue.
China’s amazing resurgence continues as the economy returns
to normal. Retail sales had been the slowest sector to come backbut September sales were 3.3% above the prior year. Households
had restrained their activity for some months over possible newoutbreaks, but the strong showing in retail reflects a broader
consumer recovery. Exports have been vigorous for months, but
solid imports in September pointed to strengthening domestic
demand. Credit expansion was sizeable in the latest data withtotal social financing rising 13.5% over the prior year. The healthy
recovery will persist with strong growth in the fourth quarter andsustained progress in 2021.
Daily new U.S. COVID-19 infections keep making new all-timehighs. Single-day new cases exceeded 90,000 on October 31 forthe second day (here) and pushed the seven-day moving average
to a new record above 79,000. New daily fatalities have been
flat—around 800 the last 10 days—and are well below the highsof both spring and summer.
Renewed restrictions on U.S. economic activity from risingdaily cases have been limited so far. Absent a stronger second
wave of infections, the U.S. economic rebound appears to havecompelling momentum to carry into 2021. Capital spendingis brisk; shipments of nondefense capital goods ex aircraft are
nicely above year-ago levels. Record new orders for similar
capital goods are a great omen for further healthy investment.
Housing activity is booming, with homebuilder confidence
at record levels the last two months. Household formation isincreasing rapidly and suggests that housing starts and homesales will stay spirited.
Surveys of manufacturing businesses by regional Federal Reserve(Fed) banks are uniformly robust. The national business surveys
by MNI Markit News International are also healthy; the Octobercomposite index tied the best level since July 2018. The service
sector was hit the hardest by the pandemic, yet even the index
level for services companies is the highest since June 2018. Job
gains should stay healthy: the American Staffing Associationindex of temp-help jobs keeps improving. The Conference Board’s

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 condition may be significantly different than that shown here.

index of job availability is the same as November 2016 when thejobless rate was less than 5%. Good job growth and a high savings
rate should fuel solid consumer spending gains well into 2021.
Besides validating the astonishingly fast resurgence in the third
quarter, the U.S. GDP report had some clear signs that therecovery will continue. Total inventories actually fell slightly (i.e.,
accumulation didn’t add to growth). With inventories extremelylean after pandemic-induced production lapses, restocking willkeep industrial production expanding. Further, net exports(exports less imports) subtracted three percentage points fromgrowth, a much larger-than-typical loss, as imports roared backmuch faster than exports. As other countries recover from thepandemic recession, U.S. exports should pick up dramatically andadd significantly to growth.

should be positive for the stock market at least for a while. Fromthe markets’ current highly valued perch, any intermediate-term
uptrend will surely be modest. Growth may slow a bit under a Biden
presidency, as the economy realigns to his priorities. That could keep
long-term interest rates lower for a little longer.
How could such different election scenarios result in mostly similar
financial market outcomes? In part because they’re global trends
that will continue regardless of who’s in the White House. Think fiscal
policy and fading globalization. Since the 1980s, monetary policy
had been the main tool to combat recessions. The Fed would lower
interest rates to stimulate consumption and investment. Fiscal policy
had gotten a bad rap in the 1970s with high inflation and stagnant
growth. Now, massive fiscal spending is combined with aggressive
Fed bond purchases to reinvigorate the economy; it’s the same in all
major developed countries.

We expect fourth-quarter U.S. real GDP growth to be in the 4% to
6% range. A safe, effective and available vaccine(s) early next year
could keep the recovery moving at a 3% pace or more for several
quarters. Absent that, the leisure and hospitality sector will be slow
to rebound and keep 2021 U.S. growth near trend, around 2.5%.

Globalization has been slowly fading for some time. Two decades offast wage growth in China made that country much less competitive
than in the 1990s. In addition, populist policies voted in by thoseleft behind by globalization or whose jobs left for China slowed theoutsourcing trend. Now, the pandemic has provided another reason
for countries to reassess their economic dependence on, and supply
chains in, China. Reshoring of U.S. jobs will likely continue regardlessof the election.

Looking ahead

Financial market outlook

After an incredible third quarter bounce in world economic
activity, the intensity of the rebound is stepping down. The recovery
clearly hit an air pocket in Europe with new restrictions following
a significant second wave of infections. So far, the rise in U.S.
new virus cases hasn’t impeded growth; Transportation Security
Administration traveler counts, weekly store foot traffic data from
Cornerstone Macro research, and consumer spending fromtracktherecovery.org stay in a modest uptrend. Good demand
from China, super-low interest rates, and a weaker U.S. dollar are
good fundamentals for developing countries. Central banks stay
supportive and more fiscal spending is on the way.

The above combination of considerable fiscal spending, financed
in part by central banks, plus the fading of disinflation, fostered by
globalization, suggests this decade will be characterized by more
inflation than expected by the consensus. That’s also the goal ofcentral banks. Sustained inflation at or somewhat above the target
of 2% implies measurably higher yields on long-term government
bonds. Moderately higher inflation would also imply faster nominal
growth. Such a change in the investment environment should spark arotation away from growth and tech stocks into those sectors that dowell when growth picks up, such as materials, industrials, financials,
and small caps—all underperformers for years.

The rebound is moderating but not stalling. The world recovery
should persist through 2021.

Since summer, there have been several attempts by markets tostart such a rotation. All have failed to generate a lasting change intrend. The persistence of the virus and its complications is impeding
the brisk rebound that would promote a sustainable rotation andrenewed market uptrend. The height of the winter flu season is likely
December and January. Besides election uncertainty, the unknown
size of this virus wave means caution is warranted into the early
New Year.

Focus on markets and the election
September and October have an unhappy history for stock investors.
There was the market crash in 1929. A record loss on Black Monday
1987. The Russian debt default in 1998. The financial crisis collapse
in 2008. This year, investors endured two wrenching S&P 500 Index
declines of 10.6% from a new high in September and 8.9% from anear-new high through October 30. The first was fueled by concern
about too little fiscal largesse, the second by the rising storm of
pandemic infections. Now, that Index is off 6.6% in the last twomonths but is still up 1.2% for the year. In this election season, thevolatility may continue through year-end.
The differences between the Presidential candidates and theirplatforms are vast. But, the divergence in financial market
performance with various election outcomes may be less thansome expect, at least on a nine to twelve-month outlook. There
are three main election results: status quo; a Biden presidencywith a divided Congress; and a Democrat sweep of both ends ofPennsylvania Avenue. More regulation of business in the latter two
outcomes and higher taxes and tax rates in the third may not be
conducive to healthy stock market returns in the long run. However,there will surely be significantly more fiscal spending via a fourth
pandemic stimulus, plus a likely infrastructure package of varying but
substantial size, in all three scenarios.
The combination of continuing economic and profit recovery, anaggressively easy Fed, and the considerable fiscal largesse to comeWe remain mostly optimistic after that. A vaccine for the virus issurely possible and therapeutics are improving. The world economic
and profit recovery should continue. Faster nominal growth will bepositive for the stock market. We’d stick to a balanced U.S. portfolio,
but believe the coming market rotation will be good for emerging
market stocks, too. Signs that this rotation is underway are a steeper
yield curve, a renewed U.S. dollar downtrend, and persistent gains incommodity prices.
Bond investors will have a hard time finding good returns. We’d
avoid long-term government bonds, as most have negative
inflation-adjusted returns. We still favor non-traditional fixed income
alternatives--high-yield, preferred stocks, municipals, emerging
market bonds. However, we’d definitely stick to high-quality andshort- to intermediate- maturities of two to four years, as credit
spreads offer little potential gain and long-term interest rates will
gradually work higher.

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 condition may be significantly different than that shown here.

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MM9908-98 | 11/2020 | 1395834-112021

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