by Michael Matthews, Investment Director – Investec Wealth & Investment UK
2020 will no doubt go down in history as the “year of Covid”. It will also be remembered as the year of one of the most fractious US presidential elections. For us in the UK, it also marked our final departure from the European Union after the referendum on our membership. At least two of them should be less influential in 2021 though Covid remains very much at the front of our minds, personally and in business.
For investors US equity indices led the way in 2020 with the S&P +18.4%, not bad having fallen 19.6% in the first quarter. This was not down to better management of Covid or the economy, but more to do with having the right stock and sector exposure (Technology) for the times. Not only were many of the companies in the IT sector short-term beneficiaries of Covid, their “long duration” earnings streams became more valuable with the fall in discount rates.
The UK suffered a negative 2020 which again was as much about market composition as anything, although Brexit could be blamed at the margin for holding back any enthusiasm for more domestically-oriented companies. With the risk of a “No Deal” outcome now behind us, there is potential for global investors to return to the UK after several years of net disinvestment. The market could also be bolstered by corporate predators, and we have already seen signs of interest. Banks are likely to reinstate dividends in 2021, and Energy, another large sector, could benefit from global recovery.
Asia has coped relatively well with Covid, thanks to strict rules (and enforcement) and the benefit of past experience with viruses. Should the global economy recover as expected in 2021, Asia and emerging markets are well placed to benefit from a bounce in international trade. A weaker dollar, resulting from loose fiscal and monetary policy in the US, would provide additional support, as these assets tend to benefit from such a trend.
Investors have to focus on the facts in front of them and play the cards that they are dealt. Thus, despite the almost unremitting tide of doom-laden headlines, the overall outlook for 2021 is relatively upbeat.
How can that be? Two key factors sustained markets during 2020: monetary and fiscal policy. Neither element of support is expected to be withdrawn in 2021. Lessons have been drawn from the aftermath of the financial crisis, when governments were urged to cut back spending to repair their balance sheets. Fiscal prudence is no longer the case. It is notable that in the UK every re-imposition of lockdown measures has been accompanied by an extension of furlough arrangements and a host of other handouts.
Looking forward, if liquidity remains a support in 2021, what about growth? Here, too, the outlook is better. First of all, whatever we might make of current “lockdowns, it is expected they will not have the same shock impact on activity as they did at the outset of the pandemic. We are now much better prepared, and new working practices have been established. In aggregate, according to data calculated by Goldman Sachs, in April 2020 the global economy was operating some 20% below its peak level of just a couple of months earlier. Currently it is still about 9% below its peak. Even if progress is halting in the first quarter of 2021, it will still represent a massive expansion from the trough.
Second, and more practically, we have the effects of Covid vaccines. It was news of the first Pfizer/BioNTech vaccine that galvanised markets in November. The successful development of vaccines in such a short period of time should be regarded as a triumph. Although we are bound to encounter some speed humps, ranging from manufacturing and distribution bottlenecks to side-effect scares, the direction of travel is clear, as is the will to complete the journey.
It is impossible to put a firm date on when “normal” life might resume, but, things should be looking a lot better by the summer. Furthermore, there is evidence of increased net savings (admittedly this does not run through all echelons of society), and the potential for a release of pent-up demand for the things we have been unable to enjoy, positive for sectors such as hospitality and travel.
Financial markets will look to discount the recovery ahead rather than focusing on today’s bad news.
We always consider the other side, in this instance, how could this rosy scenario be blighted? Variants of the virus that were resistant to the current vaccines would be especially unwelcome. Even with tweaks to vaccines, at best, we could be looking at delays of at least several months in the vaccination programme. The other main risk would be a tightening of policy, and while we believe this risk to be minimal, it cannot be ignored. Two reasons are why this could happen: A sufficiently strong recovery to reduce the need for support or a surge in inflation expectations as demand returns. This, in turn, could lead to higher bond yields, more expensive government debts and increase the discount rate that could eventually undermine the valuation case for growth equities.
Therefore we look forward to the potential for a more positive outlook later in 2021 and continued recovery from the pandemic despite the current restrictions placed on individuals.