Descending From the “Easy Policy” Mountain Summit

Written by: Brent Schutte Northwestern Mutual

A year ago it would have been hard to imagine where we’d be sitting today. In our first-quarter 2020 Market Commentary, we laid out four markers we needed to hit in order to achieve an economic recovery. For much of the last six to nine months, as we’ve hit and made progress on all those markers, we’ve been forecasting that a broadening and strengthening U.S. and global economy would lead to a broadening and strengthening U.S. global equity market.

As we close the first quarter of 2021, that’s exactly what has played out. The rising pace of vaccinations coupled with additional fiscal and continued monetary stimulus has increased optimism. That, in turn, has led to what appears to be a broadening economy, which has led to a rising and broadening market.

This stands in contrast to the narrow economy that we believe existed from mid-2018 to mid-2020, which was caused by the global trade war and then continued with COVID-19. The response to the virus created a narrow market led by the relatively unimpacted technology sector and growth stocks, which are concentrated in the U.S. Large Cap (S&P 500) equity market. At the time, other equity market segments suffered.

But as we moved through the past year, we saw a broadening recovery take hold in the fourth quarter. The first quarter of 2021 saw a continuation of the rotation to more cyclical sectors and asset classes. During the first quarter, cyclical asset classes such as U.S. Small Cap (+18.23 percent) and U.S. Mid Cap (+13.47 percent) outperformed U.S. Large Cap (+6.17 percent), and value stocks (+11.89 percent) handily bested growth stocks (+1.19 percent).

Now, as we enter the second quarter, U.S. economic leading indicators are pointing toward rapidly strengthening economic growth. The Institute for Supply Management (ISM) Service and Manufacturing Purchasing Managers Indices recently posted historically high levels. Manufacturing notched its highest level since 1983, while the Services index posted its highest level since its inception in 1997. Validating our broadening economic commentary, of the 36 industries that are represented in the two surveys, 35 are now reporting growth. That’s up from 14 at the end of 2019 (trade war impact) and four industries in April 2020, when COVID-19 sent the U.S. economy into a plunge.

It would appear there’s no longer an argument about a K- or V-shaped recovery. The recovery looks very much like a V, as it’s now beginning to encompass all areas of the U.S. economy — even the previously beleaguered U.S. leisure and hospitality industry.

As we enter the second quarter, U.S. economic leading indicators are pointing toward rapidly strengthening economic growth.


This is not to say that there aren’t people still being impacted by COVID-19, but that number is rapidly shrinking. The last two U.S. jobs reports have shown dramatic growth, especially in the remaining COVID-19-impacted parts of the economy. Of the nearly 1.4 million private sector jobs added in the last two months, the leisure and hospitality segment leads the way with 664,000 additions as the economy continues reopening.

With vaccinations rising and the economic growth outlook firming, we believe that equity markets will move higher in the coming months, albeit at a moderating pace and with potential heightened volatility as investors ponder what lies ahead. While broad diversification remains a core philosophy, we continue to recommend investors lean into more cyclical sectors and asset classes to capture the coming economic boom.


Over the past year both fiscal and monetary policymakers have been relentlessly pushing in the same direction to get to where we are today: on the brink of the fastest growth in this country since the 1980s. The question is no longer about whether we will see growth, but rather whether its arrival will cause policymakers to shift and begin taking some of the tinder off this economic fire through less accommodative fiscal policy (tax hikes) and monetary policy (think ending quantitative easing and ultimately raising interest rates). Put differently, we are nearing peak policy accommodation and are now beginning the difficult journey of descending from the summit.

While this conversation will be amplified in the coming months as inflation rises and economic growth accelerates, we believe it is extremely premature to call an end to the economic and market rally. However, we do believe there will be increased market volatility as we navigate the descent from peak policy accommodation.

Let us address each issue separately:

Monetary Policy

The leading indicators of rising economic growth we referenced above also point nearly unanimously to rising inflationary pressures in the coming months as rapid demand, low inventories and continued supply chain interruptions collide and lead to rising prices. But this is not unexpected early in an economic cycle, and we believe the Federal Reserve will view it as temporary and will not raise rates in response. Today’s Fed is different than those of the past. This Fed is determined to keep policy accommodative and not risk short-circuiting the recovery, even if inflation rises.

The “old” Fed, scarred from the Great Inflation of the 1970s and early ’80s, fixated solely on keeping inflation low and attempted to moderate the business cycle. It did so by raising rates gradually on the path toward 2 percent inflation. The “new” Fed, after the sluggish and uneven recovery of the last decade, has promised not to tighten policy until inflation is well above 2 percent for a sustained period. More importantly, today’s Fed is focused solely on the employment mandate and trying to ensure that prosperity reaches all Americans. Even if inflation rises, we believe the current Fed will ignore it until the country hits its employment goals.

This Fed is determined to keep policy accommodative and not risk short-circuiting the recovery, even if inflation rises.

The current unemployment rate is 6 percent. But there’s more to the story. There are 8 million to 9 million fewer people working than pre-COVID-19. In addition, a further 4 million people have dropped out of the labor force, so they are not reflected in the unemployment number. The Fed’s goal is to bring all of these people and potentially more back to work. Even at a pace of 500,000 to 700,000 jobs a month, this is likely a nearly two-year endeavor.

Fiscal Policy

Over the past year the government has approved nearly $5 trillion in relief/stimulus spending, and there are ongoing conversations about $2 trillion-plus in infrastructure spending. Until now, stimulus spending has been a one-way discussion bereft of any talk about how we eventually pay for it. As the economy heals, proposed corporate and individual tax hikes are becoming a part of the conversation. This threatens to cause market consternation — but it’s not likely to be over whether the market rises or falls, but whether it rallies a lot versus a bit less. While this may have some impact in the intermediate to long term, in the nearer term we believe the overall fiscal impulse remains positive.

The monetary and fiscal policy that has been heavily deployed over the past year has helped to push the U.S. economy forward and equity markets higher. Now we are beginning to descend from the top of the “easy policy peak.” While I have never climbed a mountain (nor do I intend to), I was surprised to discover that descending from the summit is often more treacherous than climbing to the top. If we equate this to the equity markets, it’s like saying that while the past months have felt difficult, we believe the easy money has been made. Another way to think about that: Returns are always the greatest when uncertainty is highest and policy is pushing forward. There is still uncertainty, but the clouds are clearing; and the conversation is shifting to removing policy and paying the bills.

Despite this, we expect the U.S. economy and markets to continue moving higher in the near to intermediate term. Overall policy is still stimulative, and the U.S. economy has a lot of economic momentum that will propel us forward in the coming years. We have an inventory rebuild underway, and most importantly, U.S. consumers have saved a large amount of their paychecks and stimulus payments over the past year. As the economy reopens, jobs return and confidence spikes, it’s likely that the U.S. consumer will unleash some of the $3 trillion-plus in excess savings they’ve accumulated on their balance sheets.


As Mark Twain once said, “Prediction is difficult — particularly when it involves the future.” This quote rings true, especially at inflection points in the economy — and we believe that recessions are inflection points in both the economy and the markets. Put differently, each economic expansion that follows a recession has had a different economic theme, and as our research has shown, each has had different market leaders.

Think about our changing Fed commentary and the endless stimulus not just in the U.S. but across the globe. Why is this occurring? Because many believe the policies of the past haven’t worked in some manner, and society has shifted. Think about the perceived traits of the last expansion: Inflation was too low, growth was too slow, globalization caused harm, and as a result, inequality rose. Now we are charting a new path, and these are the questions: What happens next? What results from all the spending and policy shifts? Have we cracked the code to economic prosperity with stimulus, or will there be costs such as more permanent inflation?

This recession wasn’t a normal recession. Indeed, it will probably be judged as the shortest on record. With all the stimulus and change among monetary policymakers who are no longer attempting to moderate the business cycle, might this next recovery be shorter? Inflation hasn’t been a problem for years, but is that shifting? Certainly, demographics and technological advances remain an inflationary headwind, but we now have adapted monetary and fiscal policy because inflation hasn’t happened recently. So does this actually make inflation more likely?

Here’s the reality: No one knows for certain. Respected economists line up on both sides of the debate. But that shouldn’t scare you. We have tools for uncertainty in the forms of a financial plan and diversification guided by an expert financial advisor. As the next expansion unfolds and trends emerge, we can shift and tweak portfolio allocations as we adapt to new realities. Consider this: No one knew exactly how COVID-19 would play out, but we believed that policymakers would respond in a quick and robust manner because they learned from the last recession. And despite all the economic uncertainty, the equity market has responded in textbook fashion, with value and cyclicals leading the way.

While the economy is always evolving and the future is always uncertain, the path to attaining and maintaining financial security remains the same: Have a plan, review and adapt the plan, and — most importantly — follow the plan even when times are tough. And from an investment perspective, remember that the flavor of the day is always shifting, but diversification is the one proven investment technique to navigate all economic seasons.

Related: 2020 Was Once in a Lifetime; Investing Was Same as Ever