“The long and winding road”
One of the lines in the Beatles classic song is “Why leave me standing here? Let me know the way”.
In many ways 2020 was an investment year where, on the face of it, it appeared that in investment terms we stood still and that the future direction of markets was very uncertain. In reality nothing could have been further from the truth.
The COVID-19 crisis prompted the fastest bear market in history and brought an end to an economic cycle that had been on the wane for the previous 12 months. The precipitous falls in late February and March 2020 were followed by the swiftest rebound ever witnessed, propelled by an unprecedented monetary and fiscal response by Governments, Central Banks and other Policymakers. As we progress into 2021 a new economic cycle is in its infancy with the potential to offer the potential for a strong recovery in the global economy.
Looking at stock markets in 2021 we see several macro-economic themes that will determine the direction of travel in the next 12 -24 months:
Monetary and Fiscal Support
Ongoing Policymaker support will be a key driver in determining the recovery prospects for the global economy. It seems clear, due to extended periods of lockdown in the developed world, that the extension of fiscal bridges will be a crucial element to allow recovery tailwinds to build. Spring looks like the earliest time this type of financial support could be safely withdrawn. The extension of Furlough in the UK until April is indicative that the UK Government realise this is a crucial support for the economy, to enable the vaccination programme to build momentum and protect the population and the NHS.
Similar fiscal extensions are being rolled out across the world and the package of support that President Biden has proposed to support the American economy, $1.90 trillion, equates to 15% of USA GDP.
The impact of this monetary support will be an extended period of low interest rates which will have the effect of making good quality Equities look very attractive as a means of participating in the hoped-for recovery. The potential for Dividends from Equities offers the potential to provide a real return in excess of fixed interest investments such as Government Bonds. A cushion of 2-3% offered by Dividend producing Equities looks very attractive in a world of near zero rates.
The expectation is that we will see a robust recovery in Quarters 3 and 4 of 2021 as pent-up demand is unleashed against a backdrop of reduced restrictions, enabling life and economic activity to gradually start the return to a more normalised basis.
Inflation
In normal circumstances, with the enormous amount of financial support and liquidity pumped into the global market, concern would already be rising about the onset of inflation. An economic recovery could produce an uptick in inflation and cannot be discounted, however there a couple of reasons why this does not look likely in the short-term. The Federal Reserve have adopted an average inflation target that will allow for above average inflation for a period before policy action would withdraw support and lead to a change in interest rate policy. The US could pierce the 2% inflation ceiling but perhaps not until 2022/23. Structural disinflationary problems in Europe and Japan should keep a lid on inflation in those economies for the medium-term. Central Banks have indicated clearly that they will be willing to put up with inflation “running hot” for a period to allow the global economy to recover from the impact of the Pandemic. A benign outlook for inflation is supportive for risk assets and therefore this is another reason we see Equities as an attractive place to be allocated to at this time in the investment cycle.
The Great Rotation
Growth stocks have been in the ascendancy for many years and value stocks have lagged significantly. During the first lockdown it was growth “stay at home” stocks that really surged as companies such as Zoom, Amazon and Netflix helped consumers and companies cope with the pandemic. Technology was therefore the equity story of 2020 and valuations in that sector have reached heightened levels. President Biden has clearly signalled that he will be looking carefully at the dominant position that the mega-Tech companies have and this could cause value erosion and potential break-up of some of the business areas in which these companies operate. Bearing in mind that 70% of the growth in the US stock market in 2020 is attributable to Technology companies President Biden’s approach will have to be monitored carefully.
Since the first vaccine was announced in early November value stocks started to stage a big recovery. Travel Companies, Hotel Groups, Airlines, Leisure and some Retail stocks have moved ahead strongly on an expected rise in consumer spending once the vaccination programme starts to impact the R rate and social interactions moves back towards normality. As evidence of the potential for this scenario to become a reality, we can see that “M2”, the measure of money supply in the economy that is readily convertible into hard cash, is at levels not seen in over 100 years (Source: Refinitiv Date, FRED – St Louis Federal Reserve). Consumers have money to spend but will they spend it ? The jury is still out on this topic and the direction of travel for this will be significantly impacted by the effectiveness of the vaccine roll-out and uptake by the population.
The other factor having a significant bearing on asset classes is the impact of environmental, social and governance (ESG) considerations as part of the investment decision process. The focus on climate change, especially now the USA have re-confirmed their alignment with the Paris Climate Change Agreement, means that this area is being more significantly integrated into the analysis process carried out by Fund Managers and investment committees. The Chinese leadership have also stepped up their intent to move towards carbon neutrality.
COP26, which takes place in Glasgow in November 2021, is seen by many as the final chance to bring in far reaching guidelines to address climate change, the way we live, produce our food and power our world. Interestingly independent research shows that companies with the highest ESG ratings have collectively outperformed during and after the March crash. It seems certain that ESG adoption will accelerate in 2021 and this will have the potential to impact investment decisions on the stocks being invested in by Fund Managers. This area also looks like a fantastic growth opportunity for the future, as Trillions of Dollars will be spent on renewable projects over the next few years to meet the worlds requirements. This will have the double benefit for Governments of reviving ailing economies and going green.
Taking all of these factors into account where do we think growth will come from in 2021. We would favour Equities over Fixed Interest for the reasons outlined previously. Our stance would be that a multi-asset approach, that broadens the asset exposure within an investment portfolio and provides diversification, would be the most sensible way to participate in market momentum. Having all your eggs in the one basket has never proven to be a successful long-term strategy so we would be looking for real estate, higher yielding credit and infrastructure to be diversifying factors in a balanced portfolio. These kind of holdings would help assist the downside protection that traditionally would be offered by Government Bonds.
In terms of Geographical exposure, the last decade has been where holding US stocks has been the place to be. Looking forward there are other areas that are offering a more persuasive story for consideration. There has undoubtedly been significant economic scarring caused by the Pandemic and developed countries have borne the brunt of the financial damage. Asian economies have proven to be more resilient in navigating COVID. This has been partly due to their ability to enforce tighter lockdowns, the experience that they have gained historically when dealing with Severe Acute Respiratory Syndrome (SARS) and developing and adopting more efficient track and trace platforms that helped stop the spread of the virus. Government support in these economies has not had to be as significant as in the West, therefore balance sheet damage has been more limited. These factors indicate that Asia will offer the potential for outperformance relative to developed economies. Favourable demographics and a growing middle class are strong indicators of the potential offered by these economies. Continued Dollar weakness will also help Asian economies and as mentioned previously we expect the Dollar to remain relatively weak as the Fed keep monetary policy accommodative and interest rates lower for longer.
The resolution of the initial Brexit negotiations, albeit there are still issues to be resolved, avoided the worst scenario outcome of a disorderly exit without a more favourable trading structure to work within. The impact of a potential “no deal” has held back the UK since the initial vote to leave took place. The UK stock market has been left behind as one of the cheapest globally with many portfolio allocators light on UK stock exposure. The significant exposure to commodity shares within the FTSE 100 could prove to be highly beneficial as the world economy opens up for business post-COVID.
The more advanced vaccine roll-out programme in the UK, compared to other developed economies, offers the prospect of a quicker opening up of the domestic market which lends itself to improved earnings for Corporate UK compared to the same period last year. Overall then the outlook for the UK stock market looks more favourable relative to many other markets.
In summary, 2021 is a re-boot year for the world economy. The gradual return to normalised business activity and social interaction will undoubtedly offer the potential for significant pent-up demand to be released, probably in Quarters 3 and 4 of 2021. There will still be headwinds to be faced at different times in relation to potential virus mutation and the withdrawal of support schemes such as furlough in the UK, with the resulting unemployment that this will undoubtedly bring. Overall we think a combination of Government and Central Bank support should give the economies of the world the necessary time to move back into a growth phase and the expectation is that global GDP this year will be of the order of 5.20% and 6% in 2022 (Source: IMF 21.01.2021), this compares with (-4.40%) Global GDP in 2020.
There is hope and there are strong reasons to expect a better year ahead for risk assets. In reality, it would be hard for 2021 not to be better than 2020.
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