Written By: Markus Schomer
Markus Schomer of PineBridge Investments explains how, following an unprecedented global response to a massive exogenous shock, policy remains the driving force for economies and markets in 2021
The Covid-19 pandemic’s arc, and its impact on political and policy developments, are resetting expectations and will continue to define the investment landscape. The interplay of these “three P’s” – the pandemic, politics, and policy – will have implications for portfolio allocations extending far beyond the coming year, resetting expectations for everything from interest rates to asset valuations.
Economic outlook: policy takes the reins
The Covid pandemic has reinforced and accelerated a shift toward policy-driven market regimes, with massive monetary and fiscal stimulus the key to bridging the gap to recovery. Politics – particularly elections, which can rapidly shift policy goals – pose the greatest risk in a policy-driven market environment, and following the pivotal US presidential election, Brexit and upcoming contests in Germany and France are developments to watch.
We believe global growth expectations may be starting to turn after contracting steeply earlier in 2020. The International Monetary Fund (IMF) dropped its forecast for the world economy from 2.9% in January 2020 to -3% in March and -4.9% in June, but has since revised its forecast to -4.4% – still a steep decline, but a sign that expectations are improving.
In our view, we are in a new business cycle where growth is reacting to mechanical closings and reopenings of the economy, making traditional forecasts largely backward-looking and less meaningful. Our preferred growth measure looks at the rate of change in GDP between fourth-quarter 2020 and the same period in 2019, the last “Covid-clean” quarter.
Our year-over-year forecast for the GDP-weighted developed world average growth is for a 3.8% contraction in fourth-quarter 2020, with countries including the US (-2.4%), Japan (-3.2%), and South Korea (-2.1%) expected to outperform the peer group average. In fact, Taiwan is the only economy in this group expected to recoup its recession losses before the end of the year. As a result, these countries are likely to experience slower economic growth in 2021 as they converge more quickly to a more normal GDP growth trend.
Meanwhile, countries with larger recession gaps, such as Canada (-6.6%), Singapore (-6.8%), and the UK (-9.2%), will remain in the mechanical phase of the cycle for a more extended period and will likely experience stronger growth rates next year. However, critically, that will not be an indication that they are speeding away from their peers, but rather a sign of how far behind those economies are in the process of returning back to normal, fundamentally-driven growth rates.
Multi-asset outlook: new cycle, new policy mix, new market leaders emerge
The best returns typically occur in the first several years of recoveries, and we see a sustainable recovery in its early phases for economies and markets, built upon the rebooting of monetary stimulus, sufficient fiscal stimulus to get the job done, and an extraordinary scientific response to Covid-19 that will likely soon produce an effective vaccine – a process that took approximately one year instead of the normal four. We expect a temporary slowing, assuming total lockdowns of unknown duration do not return, and an above-average year in 2021 for most risk asset returns.
As the pillars supporting a recovery demonstrate staying power, a sustainable early-cycle expansion should emerge, broadening out the equity rally. US stocks, which had benefited from narrowing into secular winners plus defensives, are likely to cede their leadership (while still performing in line with global stocks), while select Asian as well as European markets begin to take the lead.
With Asia’s sturdier hand in dealing with the virus and the strongest economic prospects heading into 2021, we think Asian investment grade (IG) credit may also provide some of the best risk-adjusted returns from here.
Credit segments backstopped by the Federal Reserve, including US corporate investment grade credit, have quickly returned to fair value after rallying earlier in 2020. Non-backstopped credits in many countries remain attractive, however, and interest rates above local inflation can still be found in many emerging markets.
Gold and other real assets could become the biggest benefactors of shifts toward a more balanced policy mix and away from the purely monetary deluge, with fiscal missing in action, that characterised policy in the past.
Fixed income outlook: bright spots for markets on the “three P’s”
Political developments and the pandemic’s course heavily influence policy outcomes, and none of these factors can be viewed in isolation. But for fixed income markets, the extraordinary influence of global central banks – the Federal Reserve in particular – and their massive and growing monetary stimulus for 2021 will have the greatest impact. Regarding stimulus, the expectation of a much smaller fiscal package combined with a Fed that will most likely extend most of its programmes should restrain additional yield curve steepening triggered by vaccine optimism. We therefore expect a more incremental steepening to play out in 2021, as much of the anticipated impact has been pulled forward.
These developments will likely yield a fixed income market in 2021 that is supportive of credit risk, enjoys better relative fundamentals in emerging markets (particularly for Asia credit), and sees continued range-bound government bond rates, albeit with an incremental steepening bias.
Therefore, our positioning headed into 2021 has been tilted to credit risk, with a relative bias toward Asia and emerging market credit. Within developed markets, we remain constructive on both investment grade (IG) credit, particularly BBBs, and below-IG leveraged finance credit, favouring single-Bs. We continue to seek security selection alpha from dispersion and divergent risks and opportunities, particularly across select Covid-impacted companies. We also see value in “trading the range” at the longer end of government yield curves, with the view that yields will rise only incrementally with transient periods of volatility.
The major secular shift we expect in 2021 is the lowering of risk premia, a trend that is likely to persist for at least five years due to central banks’ long-term adoption of a negative real policy rate bias and their curtailment of downside tail risks.
Equities outlook: pent-up demand points to a strong year ahead
Near the close of a tumultuous year in which Covid-19 delivered the most severe exogenous shock ever to hit global economies and markets, equities as a whole are nonetheless ending higher than where they started. This is thanks to swift actions by companies to shore up liquidity, along with bold responses by fiscal and monetary authorities and the development of vaccines in record time. Yet much of the equity return in 2020 has ridden on a handful of mega-cap names at the top of the indexes, which poses both risks and opportunities and points to a more stock-selection-driven market to tap potential alpha.
While Joe Biden’s US presidential win removed a key source of uncertainty for equity markets heading into 2021, questions about US Senate control, the pandemic’s trajectory, the global policy response, and the timing of a coronavirus vaccine all could move markets in the months ahead.
We believe several tailwinds will help propel equity markets in the year ahead, including the release of pent-up demand, which heralds a more stock-selection-driven market in 2021 and a move away from the narrow, “visible growth” market of 2020. We also expect equity markets to be supported by the nascent increase in market breadth and the beginning of a fundamental recovery, along with continuing fiscal and monetary expansion. We believe higher earnings revisions and rising valuations will also buoy markets.
Relative to other asset classes, equities offer some of the largest investment windows into the powerful changes shaping society and the world. These include rising consumer affluence in China and India, accelerating adoption of digitalisation, a ramp-up of the industrial investment cycle (with a focus on efficiency and climate), and the breakout internationally of globally-competitive companies from regional markets.
While shifts in news and sentiment will likely continue to move equity markets in the coming months, we think 2021 is poised to be an opportune time to invest in the most promising companies of today and tomorrow.
Article produced in November 2020.
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