2020 tested the mettle of governments, communities, markets, and individuals, and as 2021 loomed large it became clear that the markets had come out on top.
Global lockdowns brought on a sharp recession and record collapse of stock markets after the bottom fell out of the market in March 2020.
Recovery was just as swift. With no vaccine in the foreseeable future, policymakers dished out a dose of monetary and fiscal policy stimulus. Markets bounced back with a bold v-shaped rally.
The volatility and unpredictability of 2020 understandably have investors feeling a little jittery about 2021. Broadly, the economy will face some real challenges in this new year as the speed of economic recovery slows, and faith in the vaccine being a miracle solution leads to complacency. COVID-19 cases together with the introduction of more contagious new strains are seeing infection rates continue to soar. As a result, economic data is likely to be irregular in the early part of the year.
There is light at the end of the tunnel though. As the COVID-19 vaccines roll out across the globe, we expect the economy to strengthen through further fiscal stimulus and investors gaining confidence.
Another dip in economic activity in the short term may well occur, but importantly, the long-term projections are optimistic with a predicted rise in economic and earnings growth. This positive assessment is based on expected monetary and fiscal policies supporting pent-up consumer and household demand, combined with the COVID-19 vaccine distribution.
The current situation is a mixed bag. The approvals of various vaccines have progressed the post-pandemic improvement of economic growth, however, the global surge in virus cases hurts near-term growth projections.
Throughout 2020, central bank monetary policy was the stock market’s big driver. The market’s forward-looking pricing tendencies created a narrative for stocks to jump the earning gap created by the COVID-19 pandemic.
Government fiscal relief and the anticipation of high-efficacy vaccines provided support for consumers and the broader economy and this is expected to continue.
Rotation from Mega Large Cap
A perceived and actually very real disconnect occurred between the stock market and the economy in 2020.
To a large extent, this was due to the unique nature of the pandemic. The gap created reflected an economy with a handful of thrivers, while the majority of companies and industries were in a very difficult position.
For a large part of the year, the top five largest stocks in the US market’s S&P 500 by market capitalization were Apple, Microsoft, Amazon, Facebook, and Alphabet/Google. These five stocks massively outperformed the other 495 stocks. At their early September peak, they represented nearly 25% of the S&P 500, so their hefty outperformance gave the appearance index performance.
However, since early September there have been a series of rotations away for pandemic plays. We have observed a shift from growth stocks to value stocks, from large-cap to small-cap, and storybook leaders into down beaten laggers. We expect rotations will continue primarily driven by virus-related news pertaining to economic activity.
Stock valuations represent a meaningful risk in 2021, especially if earnings do not meet expectations; although multiples will get help from historically low-interest rates. Valuations will reveal sentiment indicators as well as fundamental indicators.
It’s important to remember that as the stock market recovers its position and investor optimism increases, the risk grows that disappointing news could force a sudden reversal.
As 2021 blossoms, the economic momentum from the last quarter of 2020 is slowing. That said, the global economy has the potential to make a full recovery this year from the 4.4% drop in 2020 to a growth of 5.2% in 2021, according to IMF.
We are expecting very supportive monetary and fiscal policy, combined with a global vaccine rollout beginning in the first half of 2021 leading to a strong rise in economic and earnings growth.
Stemming from this, global growth leadership will shift from the USA to Europe, also helping international stocks and a wider encompassing market advance compared to 2020.
In addition to their potential growth benefits, there are several reasons why international stocks should be on your radar for 2021. An expected weakening of the US dollar, attractive relative valuations, and the global rollout of COVID-19 vaccines, to name a few.
While the Chinese economy had spent several years negotiating a bumpy slowdown, its early recovery from the Covid-19 pandemic has meant GDP is already above pre-pandemic levels. This is likely to continue in 2021 despite some tapering in credit growth and policy support.
Despite having initially managed the COVID-19 crisis better than most, Europe has struggled through the 2nd & 3rd waves of the virus. However, beyond winter lockdowns, the outlook for a European economic and asset market recovery looks bright.
Europe is much was better prepared for a pull-back in activity, so it's unlikely lockdowns will spiral into something much worse. Policy actions during the worst of the pandemic have stabilized European sovereign bond markets and reduced tail risks for other European assets.
Low rates will stay
Central bankers globally will be among the happiest to bid 2020 adieu. They were the leaders of the response to COVID-19, pushing interest rates lower and rolling out a variety of programs and special facilities to help support the economy.
We see the potential for the US 10-year Treasury bond yield to trade in a range of 1% to as high as 1.4% in 2021, reflecting the prospects for real economic growth and recovery at a faster pace. This will search for yield at full pace and also increase risk taking behavior (ie see Cryptocurrencies).
Short-term interest rates are likely to remain anchored near zero throughout the year as the Federal and central bankers hold out interest rates until inflation rises. Consequently, global yield curves should steepen as the spread between short and long-term yields expands.
Think Thematic in 2021
In a dynamic world, a thematic approach can help identify growth opportunities. The coronavirus crisis accelerated some key themes, especially the digital transformation of the economy while showing how these themes transcend regions and sectors.
This new year will likely bring an unusual mix of early- and late-cycle dynamics, and ongoing pandemic and policy questions. Among the volatility and uncertainty, there’s a lot of good news and positive projections as the recovering economy makes way for new growth drivers.