Global stock markets had a positive end to 2020, experiencing their best month on record in November and posting several new record highs in December. Investors are optimistic that the rollout of vaccines is a sign more normal conditions could be approaching – and the social-distancing rules that ravaged economies in 2020 can end soon.
What then should we expect for 2021? Many western nations still need to deal with large spikes in unemployment, as furlough schemes and other job-support packages are withdrawn this year. This process will need to be carefully managed by governments, particularly in Europe and America, so the employment backdrop doesn’t damage market sentiment. It means that prospects are finely balanced, but there several key trends that we expect to feature.
Ballooning debt means interest rates are lower for (even) longer
Across the world there is acceptance that governments need to borrow and spend more to cushion the fall in economic activity, help businesses that have had to shut and preserve jobs. Never in human history has so much extra money been created by central banks and thrown at a recession.
Central banks are essentially creating new money for governments to spend, though they still go through an elaborate process of selling bonds or debts to the private sector only to buy them up or underwrite them. When many countries can borrow for up to 10 years at zero interest, or close to, it is much like issuing no cost currency to pay the bills.
The US Federal Reserve and other central banks have also told us that we can rely on extremely low interest rates for a long time. The Fed’s new average inflation target paves the way for it to maintain easy monetary policy for some time as it delays the point in the economic expansion at which it might begin removing support.
Some fear that markets will lose confidence and conclude this is unsustainable. Yet there is no obvious reason why this should be the case for a sovereign country with its own currency, as it can always be repaid anytime by printing more money. In the past the usual constraint came from inflation. If creating too much money generates more inflation, then the process must stop. The braking mechanism is the currency exchange rate. Issue too much new money and the currency plunges and affects living standards as imports become dearer. So far, the opposite has happened. Inflation has fallen, thanks to the collapse in demand and the surfeit of many goods and services. Plus, most countries are doing this simultaneously, so major currencies are not losing value to one another.
While it’s still important to keep an eye out for inflation shocks, so far this has been a crisis of collapsed demand accompanied by weak inflation, and we can expect an era of ‘financial repression’ where interest rates on cash are minimal, bond yields slender and governments aim to grow out of their debts over time as a bit of inflation comes through. Income-hungry investors will therefore be more dependent on the share exposure in their portfolio to provide them with dividend income, which could make a sustained come back this year as companies recover from the pandemic restrictions and gain in confidence.
Asia leads economic recovery
While the UK, Europe, the US and Latin America have struggled to contain Covid-19, hampering economic recovery, China is expected to have grown around 4% in 2020, the only major economy forecast to expand. Elsewhere in the region the impact has been less severe too, with Taiwan, Singapore, Hong Kong and South Korea also faring relatively well.
We anticipate that Asian recovery will continue to be quicker than in the western hemisphere. That’s significant as the region already accounts for half of the world’s economic activity, a proportion that looks likely to grow further over the next few years, aided by a pronounced demographic advantage, rising wealth, increased urbanisation and hardworking populations. China, India, and Indonesia in particular are creating large domestic and consumer-led markets.
Asian companies will be further provided with plenty of opportunities through a new free trade agreement (the Regional Comprehensive Economic Partnership), which covers 10 ASEAN countries as well as China, Japan, Korea, Australia and New Zealand and is expected to eliminate 90% of tariffs between the trading partners where all product components are manufactured inside the area.
Disruption continues but outperformance of Covid ‘winners’ weakens
Recently, long-suffering ‘value’ investors have been given fresh hope of a 'great rotation' in their favour. The outcome of the US election and positive news about a potential Covid-19 vaccine had a dramatic effect, spurring a move out of technology and other stocks deemed to benefit from a ‘lockdown’ world and into areas expected to capitalise on a speedier return to normal life and better economic growth.
A positive resolution to the pandemic and sustained economic recovery could favour value stocks, many of which are tied closely to economic growth, as could the anticipated increased infrastructure spending in the US following the election of Joe Biden. He proposed a $1.7trn policy aimed at making the US carbon neutral by 2050 during his campaign as well as a $1.3trn infrastructure improvement plan.
However, much depends on whether the efficacy of vaccines lives up to their promises and, logistically, how quickly they can be rolled out. Disappointments could easily see the short term trend reversed back in favour of the ‘lockdown winners’. In addition, some businesses will be forever scarred by the pandemic owing to smaller volumes of future business or worsening balance sheets. We would therefore suggest that investors looking to increase their exposure to value do so selectively and appreciate that many major long-term structural trends will remain unchanged by Covid.
For instance, the green revolution will remain a disrupter of carbon-based businesses such as oil and gas production and conventional autos. The pandemic has also accelerated consumer habits towards greater online activity. Many people will retain the remote ways of working, learning, and shopping they have become accustomed to, which means many tech and growth stocks won’t easily be derailed, especially if a low growth and low inflation world is here to stay, which makes their likey future earnings trajectories look even more appealing. However, the extent of their outperformance is likely to moderate considerably following such a stellar 2020.
Momentum builds to combat climate change
Until recently tackling climate change appeared to be primarily a European priority. Ambitious carbon reduction targets have been on the continental agenda for some time, and efforts stepped up in 2020 with a commitment to spend 30% of its Covid recovery fund on green initiatives. Yet the ‘green revolution’ is set to broaden and deepen much further in 2021.
In the US, the Democrat administration under President Biden is seeking to ‘Build Back Better’, greatly strengthening commitments to renewables, battery technology and green targets. Biden will re-join the Paris accords on climate change and aim to commit to a net-zero carbon future. Trump policy rollbacks are also expected, such as the reversing of relaxed emission standards and deregulation in the oil and gas sector. It will add to the torrent of national and corporate pledges announced in recent months and the growing consensus in support of tackling climate change.
China is also prioritising sustainable growth as part of its current five-year plan and has a target to become carbon-neutral by 2060. This may seem less ambitious than the EU’s and Biden’s 2050 target, but it would mean a significant departure from the recent trajectory of carbon emissions and environmental protections.
National ambitions could be further formalised during the 26th United Nations Climate Change Conference, also known as COP26, in Glasgow in November, and we expect a flurry of green infrastructure projects in the next few years that presents significant opportunities for investors.
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