BMO Multi-Manager People's perspective

A few thoughts for 2021

Risk Disclaimer

This document and the views expressed in it contain forward-looking assessments which can be identified by the use of terminology such as “may”, “should”, “expect”, “anticipate”, “outlook”, “projection”, “estimate”, “intend”, “continue” or “believe”.

These do not constitute investment advice or recommendations to buy or sell investments and you should not place undue reliance on such statements or returns, as actual returns and results could differ materially due to various risks and uncertainties.

Any investment involves risk as market conditions and trends fluctuate. Accordingly, investment values may fall as well as rise and investors may receive back less than originally invested.

Anthony Willis takes a detailed look at the themes that could shape markets in 2020, including:

  • Looking back on 2020 – a year in which COVID-19 changed everything and highlighted the challenges of making predictions!Vaccine rollout – deployment takes time, but effective vaccines give cause for optimism when looking beyond the next few months. We expect economies to eventually normalise with fiscal and monetary policy playing a key role.Recovery could signal the end of growth outperformance – a recovery gaining traction bodes well for value names after a prolonged period of underperformance. Our portfolios are balanced but we remain mindful of this potential.

 

  • Volatility will feature – setbacks (like the new lockdown) are likely but should be placed in the context of a longer-term recovery. We enter 2021 neutral on equities, wary of government bond prices and aware of select value in investment grade and high yield credit.

 

  • Geographic perspectives – Asia is ahead on the road to recovery so looks well placed. We’re neutral on the UK and Europe but cautious towards US equities given elevated valuation levels.

 

The backdrop going into the New Year is significantly more positive in terms of a medium-term normalisation of economic activity thanks to the rapid development and rollout of the Covid-19 vaccine.

Risk Disclaimer

This document and the views expressed in it contain forward-looking assessments which can be identified by the use of terminology such as “may”, “should”, “expect”, “anticipate”, “outlook”, “projection”, “estimate”, “intend”, “continue” or “believe”.

These do not constitute investment advice or recommendations to buy or sell investments and you should not place undue reliance on such statements or returns, as actual returns and results could differ materially due to various risks and uncertainties.

Looking back on 2020

2020 served as a reminder that ‘outlook’ commentaries tend to have a very short shelf life. We entered 2020 expecting the economic cycle to pick up slightly and while there were some concerns over valuation levels, supportive monetary policy and some prospects for fiscal easing left us with a reasonably constructive view on the prospects for the year.

Covid-19 changed everything, with financial markets reacting violently as the global economy was shut down as politicians and scientists tried to get to grips with a pandemic the scale of which has never been seen before in modern times. The pandemic remains with us to this day and will likely weigh on economic activity well into 2021 even as the very welcome vaccines are rolled out across the globe.

Looking at financial markets, the impact of the pandemic is hard to see in some places. With the rally in equities since the lows of late March, many indices ended up with positive returns for the year. Indeed, at certain points later in the year, there were some signs of what has previously been described as ‘irrational exuberance’ in some of the frothier areas of equity markets. Government bonds unsurprisingly saw plenty of support throughout the year and yields moved even lower as investors desire for safety at any price took hold. While government bond yields rose slightly over the summer as risk appetite improved, central bank asset purchases kept yields close to record lows. Investment grade bonds and high yield credit recovered well over the year from the steep falls that mirrored those seen in equity markets.

The news of the successful vaccine trials turbocharged the market recovery from November, and indeed supported a long awaited period of outperformance from value stocks and other undervalued parts of the market as cyclical stocks rallied strongly.

The key catalysts for the market recovery earlier in the year were the actions of the central banks, with liquidity injections and asset purchase schemes introduced at levels that eclipsed anything seen during the Global Financial Crisis. The central bank support helped to underpin the financial system at a time of significant stress, and the excess liquidity in the system provided significant support for risk assets. Equally, fiscal support has so far helped prevent many companies from defaulting and most consumers from losing their jobs or income. The recession of 2020 was more of an economic shock than a ‘normal’ recession and while governments and central banks have done a huge amount to try and soften the impact, the economic scarring will be felt for some time to come, not least given that 2021 begins with many countries in various states of lockdown, with potentially more aggressive measures yet to come.

2020 is not a year we will look back on with a great deal of pleasure or pride. It was a very sobering year both in terms of the human and social impact of the pandemic but also on a professional level. This felt very different from the global financial crisis, where there were plenty of warning signs over an extended period. The sudden economic stop and subsequent financial market crash was hard to position for, and the subsequent stock market recovery initially appeared to be built on very weak foundations given the economic damage that was taking place. As ever, the need to be pragmatic and adapt saw us adding risk to portfolios as we became more confident that the worst of the economic disruption had passed, and this conviction was enhanced as news of a successful vaccine emerged.

Any investment involves risk as market conditions and trends fluctuate. Accordingly, investment values may fall as well as rise and investors may receive back less than originally invested.

2021 – the risks of making predictions

As we assess the prospects for 2021, we recognise the futility of making predictions with a huge degree of conviction. However, the backdrop going into the New Year is significantly more positive in terms of a medium-term normalisation of economic activity thanks to the rapid development and rollout of the Covid-19 vaccine. The deployment of the vaccine globally will take time and significant effort, but the news of a vaccine allowed financial markets to ‘look forward’ to a return to economic growth in 2021; and if we do see a continued uptick in the prospects for more positive economic momentum we would hope to see further outperformance from the cyclical value names in stock markets, whose underperformance of the more fashionable growth names has been significant in recent years, and became even more extreme during 2020.

In the very short term unfortunately, the news on the pandemic is however, less encouraging with the likelihood of significant restrictions on activity in countries that so far have failed to suppress the virus sufficiently to escape from enduring various levels of lockdowns and restrictions. These issues may be exacerbated further in some places by a lack of discipline around Christmas, and it would appear that as the likes of the US, UK and many European countries will see restrictions extend well into 2021 and globally, travel will remain subject to significant disruption for quite possibly the whole year. The economic data shows that the services side of the economy continues to take the brunt of the pain, while manufacturing, construction and agriculture can continue relatively unaffected.

The influence of fiscal and monetary policy gets even bigger

Given that many economies will be unable to operate anywhere near potential for at least the first half of 2021, it remains extremely important that governments continue to use fiscal tools to support companies and individuals impacted by the economic disruption. We hope to see fiscal policy continue to be deployed as governments transition from ‘safety net’ policies onto fiscal stimulus to boost economic activity once the pandemic begins to ease. Governments should be able to count on the ongoing support of the central banks, who we expect to maintain extremely loose monetary policy throughout the year. Questions will be asked over the impact of such policies on the longer term – a huge amount of debt has been accumulated in fighting the pandemic, adding to already high government borrowing levels. Equally central bank balance sheets have ballooned once again and are set to get even bigger as asset purchases continue. Will inflation be on the agenda in 2021? There are certainly reasons to think so – base effects alone will push inflation higher but so long as this is not sustained central banks are likely to ‘look through’ any short-term spike and we see the bar for tightening monetary policy as extremely high. 

The potential for fiscal stimulus combined with loose monetary policy is a potent mix but we are yet to fully see the appetite for politicians to have the vision to use the pandemic as a catalyst for rebuilding, and we are reminded of the damage caused by ‘austerity’ in the aftermath of the GFC when many governments failed to make use of the environment created by the central banks of extremely low rates to borrow and invest for future growth.

COVID-19 – the light at the end of the tunnel

As we look to 2021 there are good reasons to be more positive, as there were at the start of 2020. We recognise the first few months will be tough for economies and societies as the pandemic continues; whether this begins to impact again on financial markets will depend on the continued willingness to disregard the current issues and look towards a normalisation in the second half of the year. Certainly, the pent-up demand from 2020, combined with low interest rates and generous fiscal packages should provide a significant tailwind for economies, not least if consumers have the confidence and ability to return to their normal spending habits thanks to a successful rollout of the Covid-19 vaccine. There are a lot of ‘unknowns’ in terms of our exit from this pandemic and any significant setback, be it with the vaccine or a mutation in the virus for example would likely derail risk appetite. It is also something of a concern that the consensus view on 2021 is almost universally positive suggesting a lot of good news is already priced into market levels – the broader market rally in late 2020 means that in many places at an index level many countries look expensive.

Balancing growth and value but tilting towards valuation fundamentals

With certain areas looking expensive, not least some of the tech names and growth stocks, we would hope to see 2021 as a rewarding one for the stock picking managers wefavour. While we have more balance in our portfolios in terms of growth and value than at the start of 2020, we also believe we are well positioned to benefit from any continued ‘rotation’ back into the value names that have seen significant underperformance in recent years. If our base case of an economy recovery gaining traction over the course of 2021 proves correct, then we would hope to see some of these value names perform more strongly. This should be particularly beneficial to stock markets such as in Europe and the UK where cyclical and value names have held markets back, most notably in comparison with the more growth dominated US.

Asset allocation

Our portfolios begin 2021 broadly neutral against our benchmarks in terms of our equity weighting. We do see a more positive path ahead for risk assets, or rather those many parts of the market that are more economically sensitive, whose underperformance versus high growth stocks is still close to historical extremes. As confidence builds that we will be moving into an economic recovery in 2021, supported by ongoing monetary and fiscal support we hope to see a continued rotation into some of the more beaten up names of recent years. There will clearly be economic scarring and we are not arguing that by the Spring of 2021 economic activity will be back to ‘normal’, but equity and bond markets are forward looking and there is now a path back to normality assuming the vaccine rollout is effective. We still expect volatility ahead not least as markets digest potentially bad news on the pandemic and further restrictions and lockdowns. But setbacks in markets should be seen in the context of a more positive assessment of where the economy and corporate earnings can recover in 2021 and 2022. We still see huge latent potential in the value names in our portfolios and while our ‘growth’ holdings should help us through any near-team impact on risk appetite from Covid-19 headlines, we see the pent up performance in those value names as the drivers of our fund performance going forward. In fixed income, we continue to see little value in government bonds which continue to look expensive though we accept that yields may well remain extremely low given central bank asset purchases. This may be challenged however if the inflation theme gains some traction. While there is some value in corporate and high yield bonds, we think the returns from the lows in the Spring of 2020 will not be repeated. We continue to very selectively make use of absolute return and property funds. Where held, these are orientated around niche areas of the market – we continue to avoid large and inflexible commercial property funds.

Regional allocations

Our strongest relative conviction remains towards Asia where economies appear to be recovering well from the Covid-19 shock and where management of the pandemic has beensuperior to what we have experienced in Europe and the US. We prefer Asia to the broader emerging markets though remain neutral on emerging markets overall given relatively attractive valuations and reasonable growth prospects and acknowledging that Asia makes up the lion’s share of emerging markets benchmarks anyway. We remain neutral on the UK for now but take comfort from the fact that the worst-case scenario of an end to the Brexit transition period without a trade deal has been avoided. The UK government will likely seek a ‘reset’ of the political agenda with Brexit now off the agenda and we should remember that with a decent majority in Parliament and limited fiscal constraints, this government has more flexibility on policymaking than we have seen for many years. We are also neutral on Europe which, like the UK, will see further economic fallout from pandemic restrictions, but also has plenty of cyclical stock names set to benefit from the recovery in 2021. Europe also faces fewer political headwinds in the short term, and indeed the agreement on Recovery Fund and long-term budget means that political dramas may be absent for some time. We remain underweight the US, which from the top down appears expensive with some uncertainty over the taxation and regulation plans of the soon to be inaugurated Biden administration. We are also very slightly underweight Japan – more of a function of more attractive opportunities elsewhere than a strongly negative view; indeed, we see the new government of Yoshihide Suga as building further on the reforms of Shinzo Abe. In fixed income, we continue to see no value in government bonds, not least if the 2021 recovery theme plays out.

Looking forwards to a return to normal, but being patient

Overall, we are very aware of the short-term risks posed by the ongoing Covid-19 pandemic weighing on sentiment. But as economies recover from an extended ‘shock’ in the form of the pandemic, with a vaccine in place and with continued fiscal and monetary support, we remain of the view that the outlook for 2021, particularly for some of the cyclical and value stocks that have struggled until late in 2020, is more positive. However, we still have a pretty bleak few months to get through first. How equity markets navigate the next few months will be determined by how far forwards investors are willing to look, and if they can ‘see through’ the short-term impact of further restrictions towards better times, and an economic recovery in 2021 underpinned by injections of stimulus from the central banks and governments, as well as of the vaccine itself. We still see headline risks in the short term given rising case numbers, against a backdrop of a stock market that appears to have a lot of good news already in the price, but with a vaccine now being rolled out there is the potential for any market weakness to be relatively short lived if investors have continued confidence over a return to normal over the course of 2021, with vaccines getting on top of the pandemic and financial assets supported by increasing consumer confidence, improving corporate earnings and a backdrop of ongoing support from fiscal and
monetary policy.

More articles by BMO Multi-Manager Team
No posts matching your criteria
VIEW MORE