Investment Outlook - Market Update
2020 was a truly extraordinary year with global equity markets on a rollercoaster ride, from the Covid pandemic-driven collapse in Q1 to the subsequent rapid recovery. The strength of the final quarter proved no less surprising, with new optimism from the positive vaccine news and, to a lesser extent, the outcome of the US election. We enter 2021 with much hope and confidence for a return to ‘normal’.
While very concerning Covid news continues to dominate global headlines, global markets have entered 2021 with the same optimism that dominated the final months of last year. This optimism, fuelled by the strong combination of central bank liquidity, increasing signs of governments opening their fiscal taps and, now, the very tangible evidence and expectation of vaccine rollout that will accelerate over coming months.
Our central scenario is that from late spring onwards the global economy and company earnings will experience strong recoveries from the pandemic-induced declines of last year. We expect investor rhetoric to be very different to 2020 as we now speak of vaccine and not virus; fundamentals-driven rather than liquidity-driven; reflation rather than deflation; re-opening rather than closing; return to work rather than from work from home etc. Such an outcome is consistent with further positive returns from global equities while expecting fixed income markets to struggle and underperform
The performance of the year ahead will be very dependent on investor confidence in the recovery envisioned above, but also importantly that the recovery is sustained into 2022 and beyond. This central assumption provides strong fundamental conditions for active managers to find investment opportunities in a rotation towards new winners such as value sectors, smaller capitalisation stocks and, for example, non-US developed as well as emerging markets.
Undoubtedly challenges remain, not least potential delays in vaccine rollout and/or further severe Covid relapses. Inflation may grab more attention which could itself pressurise low bond yields, resulting in a steepening of yield curves, and consequently undermining of equity markets. We will also continue to monitor geo-political fallout from Brexit and the myriad of US political events
Asset class outlook:
As an asset class, using standard P/E ratios, aggregate equity markets valuations are expensive and almost at extremes reached during the TMT bubble of the early 2000s. Relative to bonds and compared to historically low cash rates however, they remain attractive and investors continue to invest on the ‘there is no alternative’ basis. For now, at least, there is little on the horizon to change this .We do, however, continue to note, while aggregate valuations are expensive, these are inflated by the extreme valuations of some US technology names which trade at an extreme valuation relative to the rest of the stock market.
As fundamentals will matter much more this year, the upcoming Q4 earnings reporting season will be an important barometer for the health and confidence of the corporate sector. As management teams set out their stall and expectations for the coming year, the earnings season will be closely watched and we expect companies to show increased confidence in their outlooks for both earnings and dividends
On the premise that we are now at the beginning of a new economic cycle, this should also provide a good entry point for value and cyclicality and such stocks should prevail over stocks in growth and momentum areas of the market which were previous ‘winners’. With earnings growth now more available and diversified across market sectors, this should further facilitate the rotation, and the first half of the year may well be dominated by such movement. It’s early days, but we also envisage a strong return towards income investing and the ignored theme of attractively priced dividend income could well be a winner as the year proceeds.
Fundamentally, government bonds remain extremely overvalued at current historically low yield levels. They remain ‘artificially’ priced due to central bank intervention and are at present not reflective, we believe, of their true fundamental value, as both Governments and the corporate sector continue to sell bonds to fund spending at these record low yields. Some day this music will also stop!