We expect 2021 to be a year where economic growth continues on a path towards normalcy and where financial markets settle into a more traditional pattern of performance.
While risks will remain ever present, governments and central banks have laid the foundations for a solid economic recovery supported by an accelerated roll-out of a COVID-19 vaccine.
Throughout 2020, the coronavirus and the actions taken to prevent its spread drove a very clear distinction between winners and losers within and across markets. Confidence around the economic outlook is now reversing many of the performance trends that favoured structural growth and “work from home” winners within equity markets and also kept long bond yields from rising.
In 2021, we expect stronger performance by areas that are leveraged into a cyclical recovery and the removal of social restrictions. This should benefit cyclicals, value stocks, small caps and stocks which are most globally exposed.
At the same time, many of the longer-term headwinds to a strong and sustainable economic recovery have not completely disappeared with growth even more reliant on cheap and abundant liquidity. Investors must therefore not lose sight of longer-term objectives and areas of structural appeal in the chase for sexier short-term performance through the coming year.
COVID-19 has accelerated many trends which will be with us for years to come and while 2021 brings an opportunity for many areas that have lagged throughout the past year to regain lost ground, we recommend investors also use volatility and any weakness to ensure they are positioned for the longer term via exposure to areas such as technology (including 5G, AI, cloud and security) as well as a greener world (climate change, clean energy) where momentum continues to accelerate.
Global: An economic revival
ONWARDS & UPWARDS: We expect 2021 to be a year of economic recovery for both the global and Australian economies as the world charts a course back to normalcy. While the growth rebound is likely to be uneven and fitful, an accelerated roll-out of a COVID19 vaccine with much higher than anticipated efficacy rates alongside ultra-accommodative fiscal and monetary policy will ensure bouts of consumer and business pessimism have no lasting impact on confidence and activity levels.
We do not expect the global economy to recover lost output for some time to come, but the gradual removal of social containment restrictions will drive a rebound in spending on services (such as hospitality and travel) which to date have been a weak spot of the economic recovery. It is unlikely that we are back to the “old normal” within the next 12 months, but areas of strength and/or upside will come from China where output is already back above pre-pandemic levels alongside the US where geopolitical risk is likely to have stabilized at lower levels following the 2020 Presidential election outcome. On the other hand, Europe does remain a downside risk for the global backdrop.
Key Takeaways:
- The global economy will continue to improve through 2021 as a vaccine is rolled out and policy settings remain easy. Pent up demand (and savings) provides upside growth drivers.
- Geopolitical risks will remain but at a lower level than throughout 2020. China will be a powerful support for the global recovery.
- A policy mistake – a premature winding back of monetary or fiscal supports is the biggest threat to the cyclical rebound.
Australia: Who doesn’t want to live on an island?
ECONOMIC IMPROVEMENT CONTINUES: Australia’s economy is on a solid path of improvement and this should continue provided COVID-19 can be kept at bay, at least until a vaccine can be rolled out. While 2020 will be remembered for the deepest economic downturn since WWII, the recovery has been just as impressive. Most economic variables have surprised on the upside over the past 2 quarters and this is despite the extended lock downs in Victoria.
There will be some tough days ahead for the Australian economy as elevated unemployment and the unwind of emergency supports are likely to result in rising consumer delinquencies and business insolvencies. However, fears of a systemic rise in bad and doubtful debts / insolvencies is unlikely given the rapid decline in borrowing costs alongside a willingness of banks to help bridge the COVID-19 driven economic gap.
Key Takeaways:
- The economic recovery will remain underpinned by relative success at containing COVID-19 as well as ultra-easy fiscal and monetary policy.
- Low rates will boost house prices and other rate sensitive assets – the former despite net immigration remaining a strong headwind for most of 2021. The A$ is likely to move higher.
- The labour market will remain a constraint to spending despite continued improvement throughout 2021. Weak wage growth will remain a feature for the foreseeable future.
Investment Outlook: All about relative returns
Equity Markets: Following the growth recovery
EQUITIES TO RISE: We expect equity markets to continue moving higher in 2021, underpinned by stronger economic growth driving a recovery in earnings and dividends, ultra-low rates supporting valuations and abundant liquidity chasing higher returns and/or income levels as risk aversion begins to normalize. While volatility is likely to settle at much lower (average) levels than in 2020, markets will still oscillate between bouts of optimism and pessimism around the strength and sustainability of the earnings recovery and excessive valuations. Nevertheless, while the past year rewarded those willing to play a very narrow subset of the equity market (COVID-19 winners), 2021 will reward those who are willing to take on more cyclical exposure (COVID-19 losers).
VALUE AND GROWTH: COVID-19 vaccine news has quickly driven a reassessment of the cyclical backdrop and with it the outlook for “value” stocks which tend to be more cyclically exposed. We expect conditions to favour “value” over “growth” for most of 2021, but we do not recommend building an investment strategy build based only on “style”. At this stage, we believe the style rotation has much further to go – supported by the lagged effects of easy liquidity. However, we do not see value outperformance as a long-term return-to-mean reversion. This is because it depends on the sustainability of economic momentum and the durability of the rebound, of which both remain questionable if recovery is modest and uneven.
Key Takeaways:
- Global and Australian equities to both trade higher into 2021. Performance will favour cyclical (laggard) stocks and markets.
- Low bond yields will drive further inflows into equities as investors chase both higher returns and look to supplement incomes.
- Small caps meaningfully outperform Large caps as earnings normalization progresses. Value should outperform Growth but this will be fleeting.
- Commodities will also benefit from a cyclical rebound.
Fixed Income: Cyclical forces push yields higher
Key Takeaways:
- Bond yields to creep higher driven by improving economic growth and a near term normalization in cyclical inflation expectations.
- Central banks will remain dovish through 2021 and beyond as they look for strong evidence that rising inflation is sustainable beyond a cyclical bounce.
- Credit spreads can tighten further but credit worthiness will be a differentiator for some time to come. Flows will still follow superior yields into credit markets through 2021.
Alternatives & Real Assets: Opportunity to enhance returns & add diversification
Key Takeaways:
- Look for opportunities within private debt where significant yield enhancement is on offer. Private equity returns tend to be strongest coming out of economic slowdowns.
- Real Estate will perform between bonds and equities. However, sector performance will remain diverse as it balances cyclical tailwinds with structural headwinds. Look for a strong yield pickup and valuation normalization within residential.
- Commodities are likely to be mixed over 2021, with oil recovering and gold under pressure. Industrial metal and bulk commodity prices are likely to peak soon, as consumer demand
rebalances away from goods and back towards services, and Chinese growth moderates to a more normal pace.
Source | Jason Todd – Head of The Wealth Investment Strategy Team | Macquarie Wealth Management
