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2021 outlook positive, but risks remain

Despite global economic growth entering another pandemic-driven soft patch, we are constructive on equities over the next few months.

A compass with text and icons - 2021

by
Jon Cunliffe

in Features

02.02.2021

Growth will accelerate markedly as we head into the second quarter, our analysis suggests. Inflation will rise, but not to the extent that major central banks will alter their monetary policy. It will remain highly accommodative. 

A Democrat-controlled US Congress increases the likelihood of a more-aggressive US stimulus package, including significant investment in clean energy as part of a green-infrastructure programme. 

This type of macroeconomic and policy environment is strongly reflationary. This is evidenced by rising market-implied inflation rates and a steeper US yield curve – as well as a weaker US Dollar and stronger commodity prices. Assets which are cyclical often perform strongly in this type of environment.

Against this backdrop, while we still like the US market, we have recently pared-back our exposure in favour of Asia. This region benefits from a better growth dynamic and more generous valuations – whilst still affording access to tech exposure. This is important as the sector continues to benefit from the much-increased digitalisation of our daily lives. 

Turning closer to home, we would expect the UK and Eurozone markets to fare relatively better. Again, this is due to the higher weight they have in cyclical sectors – banks, energy, materials and industrials – some of which were hit hard by Covid-19-related restrictions to free movement during last year. 

Responsible and Sustainable Investing took centre stage in 2020. Now that the European Union’s Green Deal is likely to be augmented by a range of initiatives from Joe Biden, we expect both opportunities and threats to emerge for investors. On the one hand, there is now a range of good-performing green investment funds available. On the other, a lot of traditional industries – notably big oil and automobiles – are likely to face costly write-downs of capital investment over a number of years.

As a result, our enthusiasm for cyclical assets in the months ahead needs to be viewed in the context of these longer-term headwinds to traditional sectors of the economy. 

There are several risks to our constructive view on equities and cyclical assets. The rollout of vaccines could take longer than expected, or their effectiveness may prove to be lower in the wider population than indicated in trials. Write-downs and the permanent loss of capacity in damaged sectors could prove to be a bigger drag on the economic recovery than we anticipate. 

Fiscal policy could be tightened prematurely – as governments lose their nerve – causing the recovery to fade and corporate profits to disappoint. It is also possible that we see a significant overshoot in inflation which alarms the markets, prompting a sell-off in equities on the back of an upwards spike in bond yields. 

However, our base case is for global equities to deliver a high-single-digit return over 2021, with the bulk of these gains in the first half of the year.

If we look further into the future, we expect assets that can throw off a relatively generous and reliable income stream will continue to command a premium. With sovereign and corporate bond yields near record lows, the traditional 60/40 equity/bond ‘balanced’ portfolio is unlikely to be as successful as it has been in recent years.

As a result, infrastructure investments – which have strong cashflows independent of the corporate profit cycle – may be more attractive over the longer term. This includes renewable energy, underpinned by government investment programmes in the energy transition. 

Elsewhere, equities with fixed-income type characteristics – including utilities and real-estate investment trusts – may also fall into this category. So, a more imaginative approach to strategic-asset allocation is likely to be needed in the years ahead.

Nothing on this website should be construed as personal advice based on your circumstances. No news or research item is a personal recommendation to deal.

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