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Monthly Market Commentary - December 2020

The constructive market environment that started in early November continued through December, as positive vaccine news improved sentiment.

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by
Jon Cunliffe

in Fiduciary news

07.01.2021

The constructive market environment that started in early November continued through December, as positive vaccine news improved sentiment. Global equities rallied 4.5% – or 2.3% in Sterling terms – reflecting a 2.2% gain in the Pound versus the US Dollar. Elsewhere, following on from November’s strong rally, UK equities had a solid month. The FTSE 350 gained 3.6%.

Globally, growth stocks (large tech, pharmaceuticals and some consumer staples) outperformed value stocks (more cyclical sectors such as banks, oil and gas, consumer cyclicals and travel) – although this was only a partial reversal of the outsized relative gains that ‘value’ achieved in November. Last month also saw strong investor demand for sectors previously beaten down by Covid-19 restrictions.

A second wave of the pandemic and the prospect of further lockdowns is probably the key reason why the steam ran out of the rotation into value shares – but we do expect much more balance in the performance of cyclical equities versus growth stocks in the months ahead.

Commodities had another strong month, with the Bloomberg Commodity Index gaining 2.7% in Sterling terms. Expectations of strong economic activity this year – as vaccines help break the link between free movement and the spread of the virus – have helped. A further weakening of the Dollar and an anticipated cyclical pickup in inflation remain a tailwind for most commodity markets.

Taken together, these market moves are consistent with the notion that central banks have, through their market interventions during 2020, successfully guided market participants to expect a healthy rise in inflation over the next year or two. This has been reflected in a 1.3% increase in market-implied inflation expectations since last March which – in conjunction with negative real interest rates – has been a key driver of the positive re-rating of equities since last year’s dramatic selloff.

More broadly (and given the rapid rise of sovereign and corporate indebtedness in the recent past) if higher inflation doesn’t unduly trouble the interest-rate markets, it is helpful in reducing the real debt burden faced by borrowers. The challenge to financial market participants and central banks is how much of an increase in inflation can be tolerated without a damaging increase in bond yields.

As we look ahead, what do we expect for this year? After a weak first quarter due to continuation of Covid-19 restrictions, we anticipate solid economic growth and a strong pickup in corporate earnings (albeit from a low base). Elsewhere, we expect any material increases in inflation to be cyclical rather than structural, with central banks remaining dovish and able to provide ongoing policy support for markets in order to keep financial conditions supportive of growth.

We expect global equities to deliver mid-high single digit returns, but positive performance is likely to be front-loaded this year. The increasing digitisation of our daily lives will continue unabated, representing a secular tailwind where tech and Responsible and Sustainable investment strategies will continue to grow. Whilst the UK economy will remain a relative underperformer, the FTSE should perform relatively better this year, reflecting its high weight in cyclically exposed sectors. Bond returns will be modest – at best – unless growth and corporate-earnings disappoint.
So, what are the risks? The effectiveness of the vaccine could prove to be lower in the broad population than in the trials. Write downs and the permanent loss of capacity in damaged sectors may prove to be a bigger drag on the economic recovery. Fiscal policy could be tightened prematurely as governments lose their nerve, causing the recovery to fade and corporate profits to disappoint.

There could be a significant overshoot in inflation which alarms the markets and causes a de-rating of equities on the back of higher bond yields. Finally, and ending on a note of caution, perhaps, the consensus is sometimes wrong – and our optimism for the next few months is shared by many.

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