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Monthly Market Commentary - January 2021

Whilst first-quarter global growth will be at best sluggish, reflecting the recent wave of the virus in the US and Europe, market participants are looking ahead to a reopening of the global economy from the second quarter and beyond.

A businessman using a mobile device to check market data.

by
Jon Cunliffe

in Fiduciary news

04.02.2021

Whilst first-quarter global growth will be at best sluggish, reflecting the recent wave of the virus in the US and Europe, market participants are looking ahead to a reopening of the global economy from the second quarter and beyond. This should see growth peak at its strongest level for twenty years, accompanied by the strongest growth in corporate profits since 2009.

Financial markets like certainty and, if we exclude the prospect that the effectiveness of the vaccines proves much lower than anticipated, these expectations are highly likely to be realised. There is significant pent-up demand in the global economy once restrictions to free movement are progressively eased – and fiscal and monetary stimuli continue to work their way through the economy.

Reflecting this supportive background, equities began 2021 on a strong footing, building upon the gains of November and December. During the month, global equities were as much as 6% higher, with gains led by the Asia (including Japan) and the Emerging Market world more broadly. These regions have, in general, benefitted from a relatively-better growth dynamic reflecting a more successful approach to managing the pandemic, the trend of Dollar weakness, supportive global liquidity, and more favourable valuations.

However, as we headed toward the latter stages of January the market environment changed markedly. We witnessed several retail-driven short squeezes in stocks on the Robinhood platform, as retail investors were encouraged by online message boards to buy equities where short interest was at high levels.

Whilst we saw outsized gains in names such as GameStop (at one point during the month it had rallied 2,350%!) a number of hedge funds who were short these stocks were forced to cover and also liquidate profitable positions in a range of other more liquid large cap stocks to offset losses. This dynamic precipitated a sharp correction into month end, with global stocks ending the month just 2% higher.

More broadly, with strong liquidity driven gains in equities over recent months, market participants have become concerned that key markets and sectors within them may be entering bubble territory – and the sharp month-end correction could prove a precursor to a deeper market selloff.

Elsewhere, some commentators have argued that high levels of retail participation in the stock market is symptomatic of the type of late cycle bubble we saw in technology stocks in the late 1990’s.

However, whilst there are similarities there are also differences. In the West, a large majority of employed workers are at home, and with normal activities significantly curtailed the savings rate has risen as high as the mid-teens. In the US in particular, this significant rise in involuntary savings has supported a boom in retail equity market participation which has caught many traditional investors off guard and has amplified market volatility.

Elsewhere, central banks have lowered real interest rates to record low levels and continue to flood the financial system with excess liquidity, which remain a tailwind for risk assets. In addition, low real and nominal bond yields help offset high equity valuations via supporting a relatively generous equity earnings yield over bonds.

Against this background, aside from an ultimately unsuccessful vaccine rollout, arguably the biggest threat to equities would be a spike higher in interest rates on fears that resurgent demand boosted by policy stimulus could see a substantial increase in inflation. Whilst we expect a modest pickup in inflation this year, reflecting base effects and stronger growth, we expect central banks will look through this dynamic, and will be keen to avoid removing policy accommodation before the economy is well on the way to a more self-sustaining recovery.

All told, this suggests that the key central banks will allow their respective economies to run “hot” for a little while before signalling less stimulatory policies. This easy money, strong growth and rising inflation dynamic tends to be a tailwind for equities, so we remain constructive on risk assets for the time being, with regional equity preferences in Asia and the Emerging World. However, as far as financial markets are concerned, it’s often better to travel than to arrive, so by the time restrictions are eased meaningfully and growth picks up markedly we would expect to have seen most of this year’s equity market gains.

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