by Tom Stevenson, Investment Director
The past year has not smiled on forecasters. Making predictions about 2021 therefore demands even more humility than usual. Covid-19 quickly made our concerns 12 months ago look irrelevant. But it’s what we do; so, here are six themes that I expect to shape the year ahead for investors.
First, I see a steady flow of positive vaccine news as we move into the first quarter of next year. The widespread availability of jabs and the prospect of herd immunity will bring the year of lockdowns to a close. The consequent re-opening of the global economy will deliver above trend economic growth in 2021 of at least 4pc globally, perhaps as much as 6pc. Recovery will be bigger but also significantly quicker than it was after the financial crisis. From a market perspective, the biggest implication of this rapid pick-up in activity will be a rotation away from the defensive growth-focused sectors which have outperformed strongly for more than a decade to the out-of-favour cyclical companies that look too cheap in a recovering world. This is good news for financial companies, energy and industrial stocks, less good for technology, food and other consumer staples and utilities.
The upturn will be supported by the second key theme – co-ordinated fiscal and monetary policy stimulus. The appointment of Janet Yellen to head up Joe Biden’s Treasury is a very important development on this front. She, of all people, understands the limitations of central banks to stimulate growth in the real economy and the need for government spending to step into the breach. The likely failure of the Democrats to secure control of the Senate means the most optimistic fiscal forecasts for the next four years won’t be achievable. But there should still be a meaningful front-loaded spending boost next year. On this side of the pond, too, austerity has been shelved for now; Rishi Sunak will hopefully hold fire on the fiscal repair job he is itching to make a start on.
The combination of these first two themes will lead to the third – another good year in stock markets after this year’s surprisingly good outcome. The V-shaped round-trip for investors in 2020 is looking like a typical event-driven bear market and recovery. These tend to be done and dusted more quickly than the cyclical downturns caused by rising inflation and interest rates and to be faster and shallower than the structural bear markets that are triggered by financial or real estate crises or asset price bubbles. The first phase of the new bull market has been powered, as it always is, by rising valuations as hopes have risen; the next, probably much longer, phase will be fuelled by rising earnings. Although markets have been advancing for more than a decade, the evidence of first the 1950s and 1960s and then the 1980s and 1990s suggests the bull can run for much longer than we think.
The expected strong performance of shares will be accentuated by a fourth theme, the start of a long-term switch out of bonds into equities as interest rates hit their natural lower limit at, or marginally below, zero. After decades in which the direction of interest rates was relentlessly lower, central banks now recognise that further cuts into negative territory will be counter-productive. With governments obliged to inflate away their massive debt burdens over time, the interests of policy makers and bond investors are no longer aligned. Bonds no longer offer risk-free returns – more like return-free risks. And if fixed income investments no longer offer a hedge against stock market volatility, many investors will question why they are not instead enjoying the growth and income combination still offered by shares.
The fifth theme is also an asset allocation shift, this one between regions. Ever since the financial crisis, investment success has largely been about one key decision – how big an exposure have you had to the US stock market? This has reflected, first, stronger earnings growth in America and, second, Wall Street’s bias towards the increasingly highly rated technology sectors. Higher growth and higher valuation multiples have proved a potent combination. If the rotation to value does accelerate next year then the US will look less relatively attractive, particularly if the dollar weakens. Other markets, like the UK, are more exposed to a pick-up in cyclical sectors than the US and much less highly priced. The valuation argument is particularly strong in our domestic market after four years of fretting about the impact of Brexit. Emerging markets also look cheap. With trade tensions easing under a Biden presidency, higher-quality earnings than in the past and, in Asia at least, the benefit of being first in and first out of the pandemic, emerging markets could be the best-performing region next year.
Investors need to prepare for these shifts in asset class, regional allocation and investment style. But the final theme for 2021 might have even greater long-term implications for the way they manage their portfolios. One of the most striking investment findings from this pandemic year has been the clear price out-performance by companies which rate highly on environmental, social and governance factors. Sustainable investing has entered the mainstream this year for the simple reason that doing the right thing is not just desirable but profitable too. The correlation between sustainability and stock market performance is clear. As we grapple with the inequalities highlighted by Covid-19 and prepare to host next year’s COP26 climate change conference, investing in the solutions has never mattered more. Of the six forecasts here, the growing importance of sustainability looks to be the safest bet.