We believe that vaccine prospects are likely to make 2021 a year of global economic recovery. While markets have priced in a fair amount of the good news, more gains seem possible as corporate profits rebound and central banks remain on hold.
With the world in the early post-recession recovery phase of the business cycle, our medium-term outlook for economies and corporate earnings is positive. We believe that 2021 will feature an extended period of low-inflation, low-interest rate growth that favours equities over bonds.
There are some near-term risks, however, such as investor sentiment, which has become overly optimistic following recent vaccine announcements. This makes markets more vulnerable to negative news, which could include renewed lockdowns in Europe and North America as virus cases escalate, logistical difficulties in distributing the vaccine and negative economic growth in early 2021—if government support measures are unwound too quickly.
Geopolitics could also deliver negative surprises from China, Iran or Russia as the new administration of President-elect Joe Biden takes power in the United States.
Our cycle, value and sentiment investment decision-making process scores global equities as expensive (with the very expensive US market offsetting better value elsewhere), sentiment as overbought and the cycle as supportive. This leaves us slightly cautious on the near-term outlook, but moderately positive for the medium-term, with expensive valuations offset by the positive cycle outlook.
In the US, there will likely be two distinct phases to the path forward. The first—over the northern winter months—looks challenging, as Covid-19 infections explode across the country, leading to partial, localised lockdowns. However, once a vaccine is widely available, we believe that dislocated sectors (eg, restaurants, travel and hotels) will bounce back strongly, likely in the second half of 2021. Meanwhile, the Federal Reserve (the Fed) continues to maintain an ultra-accommodative policy stance. Even with our expectation for a robust 2021, the Fed’s focus on generating an inflation overshoot should leave plenty of runway for the expansion to strengthen and broaden.
The three biggest challenges we see for markets are the concentration risk in major US equity benchmarks—which have a composition skewed toward the stay-at-home mega cap technology stocks, moderately expensive valuations in equity and credit and an increasingly optimistic industry consensus.
In Europe, the second wave of virus infections has reversed the third-quarter V-shaped recovery, with the region on track to record negative GDP (gross domestic product) growth in the fourth quarter. The new lockdowns are working, however, with infections across the region having peaked in early November. We believe that Europe is poised for a strong post-vaccine recovery. The region is also more exposed to global trade than the US and should be a beneficiary of a recovery in Chinese demand. Notably, after five years of underperformance, we expect the MSCI EMU Index to outperform the S&P 500® Index in 2021.
Covid-19 and Brexit uncertainty have battered the UK, with the FTSE 100 Index the worst performing regional equity market (by a wide margin) in 2020 to date. However, we believe it could be one of the better performers in 2021. The UK market is cheap relative to other markets and is overweight the financials, materials and cyclical sectors that should benefit the most from a global recovery.
The Chinese economy has returned to almost pre-pandemic output levels, which is a significant achievement, given the depth of its first-quarter downturn. We think that fiscal policy in China will remain supportive through 2021.
We believe that Japan’s rebound from the pandemic is likely to lag other developed economies, despite its less severe Covid-19 outbreak. This reflects the structural weaknesses that were in place before the pandemic, such as subdued consumption from its ageing population.
Australia has controlled the virus outbreak better than most other countries and, with a relatively open economy, is poised to be a beneficiary of the post-vaccine global recovery. The year 2021 is likely to see an expansion of the Reserve Bank of Australia’s quantitative easing program.
In Canada, we believe that the country’s exposure to commodities—particularly oil—will benefit from a rebound in the global economy. While business investment may be slower to materialise, both the housing market and improving commodity prices will likely serve as foundations to an economic recovery.
• Once a vaccine is widely available and lockdowns have been eased, we believe that normal early-cycle recovery dynamics should resume, with a rotation toward relatively cheaper value and non-US stocks that are likely to benefit from a return to more normal economic activity
• The most notable damage from the pandemic has been the rise in government debt. However, we think it’s unlikely that governments will start to trim deficits through tax hikes and lower spending anytime soon
• In the US, we believe that the post-vaccine recovery period will lead to real GDP growth in excess of 5% in 2021.
• We believe Europe’s exposure to financials and cyclically sensitive sectors gives it potential to outperform in the post-vaccine phase of the recovery, when economic activity picks up and yield curves steepen
• Major central banks have made it clear that they will wait until after inflation rises before raising rates. We think a slow-acting Fed should limit the rise in the 10-year U.S. Treasury yield to between 1.1% to 1.4% - compared to its current level of 0.85% in early December
Asset class views
Equities: Preference for non-US equities
We prefer non-US equities to US equities. The post-vaccine economic recovery should favour undervalued cyclical value stocks over expensive technology and growth stocks. Relative to the US, the rest of the world is overweight cyclical value stocks.
We like the value in emerging markets (EM) equities. China’s early exit from the lockdown and stimulus measures will likely benefit EM more broadly, as should the recovery in global demand and a weaker US dollar.
Fixed income: Bonds universally expensive
We see government bonds as universally expensive. Low inflation and dovish central banks should limit the rise in bond yields during the recovery. US inflation-linked bonds offer good value with break-even inflation rates well below the Fed’s targeted rate of inflation. We view high-yield and investment-grade credit as slightly expensive on a spread basis, but believe they have an attractive post-vaccine cycle outlook.
Currencies: US dollar likely to weaken during recovery
The US dollar should weaken amid the global economic recovery, given its counter-cyclical behaviour. The dollar typically gains during global downturns and declines in the recovery phase. The main beneficiaries should be the economically sensitive commodity currencies - the Australian dollar, the New Zealand dollar and the Canadian dollar. We believe the euro and British sterling are undervalued, and expect that both currencies will be boosted by the post-vaccine recovery.
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