Q4 Summary and Outlook

January 14, 2021

Three successful trials, successive regulatory approvals and the beginning of a global vaccine rollout have changed the tone and sentiment in the market to this pandemic. After nine months of extreme short-term market movements that have reflected the latest news on the pandemic, markets are now looking ahead to the spring and beyond.

Despite the reintroduction and rising severity of lockdowns; November witnessed the best month for stock markets since 1987 as confidence returned to energy, financials and other pandemic losers. Healthcare, technology and consumer staples have lagged, but the rising tide lifted all boats and these sectors experienced single digit gains over the quarter.

US election risks were probably overstated, and in the end the result appears to be a positive one, with a steadier pair of hands at the helm from a global trade and geopolitical perspective. A divided senate should be positive for corporate bottom lines by limiting the tax implications of Democrat policy, but there is a slim chance that Biden will find himself with a deciding vote following Georgia’s runoff elections in January.

Looking ahead there is potential for a very significant economic recovery in 2021. This pandemic has caused the fastest and shortest bear market on record but, unlike other economic crises, consumers have managed to build their savings whilst not being able to spend during lockdowns. In the first half of 2020, cash in US household bank accounts increased by $2.1 trillion, circa 10% of GDP. Consumer spending capacity is improved by the wealth effect of a resilient housing sector, bolstered by pandemic led demand for better homes and ever lower interest and mortgage rates. These factors indicate a significant amount of pent-up demand. China is emerging as a pandemic winner. The US, UK and strong European economies will likely take until 2021, 2024 and 2022 to recover, respectively.

The speed of the vaccine rollout has been extraordinary. In the United Kingdom over 600,000 people were vaccinated before Christmas. Initially targeting the vulnerable and key workers, there is a target of 25% of the population receiving the vaccine by Q2 2021 with 50% by Q3 2021. Ideas of the “new normal” may subside and there is now huge impetus for a return to the old normal. In this scenario, leisure and hospitality sectors would be the main beneficiaries and the high levels of unemployment experienced by these sectors could be reversed rapidly.

Central Banks remain accommodative and interest rates are expected to remain low in the medium term. We have seen unprecedented monetary stimulus this year, the most dramatic growth in money supply on record, and, if as successful as monetary policy has been in recent history, this should feed into the economy in the year ahead.

Governments are expected to ramp up fiscal spending with an emphasis on encouraging long-term investment in modern economy infrastructure such as 5G, fibre, clean energy and education. Debt to GDP ratios are close to 100% in many major developed economies but high deficits will be maintained as managing them down presents a greater potential risk to the economic recovery.

Attention towards the environment has increased in recent years and we appear to have more global consensus as the US re-joins the Paris Agreement for climate change. The decade ahead is highly visible in terms of major changes in this regard, giving governments a clear focus for investment. Electric vehicles will be rolled out with renewable energy infrastructure becoming a significant proportion of the energy mix. Hydrogen and battery technology will support energy storage. We anticipate environmental, social and governance considerations (“ESG”) will become an ever-increasing factor for investors and capital flows into companies with strong ESG credentials can result in higher valuations.

Reflecting on a difficult year, we can be encouraged by the innovation born out of catastrophe. The mRNA vaccine represents proof of concept for a relatively new science which has exciting implications. With a significant role in analysing the coronavirus, genome sequencing has accelerated this year and is expected to add $1 trillion of value by 2025 through better treatment outcomes. The NHS is to trial a blood test that can check for 50 types of cancer, and areas in California that have been devastated by wildfires are going to be re-seeded by drone - we can expect they will find their way into farming and logistics in the years ahead. Improvement in technology infrastructure, increased digitalisation and the extensive efficiency boosting, cost cutting exercises which were undertaken in 2020 should not be discounted as adding value. We are still in the emerging stages of the digital information age.

As always, there remain risks. Whilst the financial system has worked impeccably this year, there are repercussions to the Central Banks having provided almost unlimited liquidity. The first is inflation but it has yet to emerge over a decade into this cycle, so it appears the world is sufficiently capable of scaling up supply to meet rising demand. The second is the ever-increasing global debt pile; its existence alone may not adversely affect asset prices, but it will be no surprise if the next bear market reflects concerns on how this unprecedented issuance can ever be repaid. The graph below shows the stable spread between 5Y5Y and 30Y, which has persisted since April. The 5Y5Y swap rate is used as a market measure of what five-year inflation expectations will be in five years’ time. This is often thought of as a proxy to the terminal Fed fund rate. We use this to examine the interplay between fiscal and monetary policy. The 5Y5Y is telling us that the Fed is stuck at zero for a long time.

China has had great success in containing the virus; their economy, albeit at a slower pace than usual, is expected to grow this year. This is an impressive feat and the fiscal and monetary response to the COVID-19 crisis was significantly smaller in Asia. As a result, the decade ahead could be one in which Asia outperforms, benefitting from a significant proportion of the world’s population, the proliferation of technology and the Regional Comprehensive Economic Partnership. The region will likely become more attractive to investors as Chinese markets continue to open up and there is potential for greater access to China’s currency.

President Trump’s unwillingness to concede to Biden and renewed US-China trade tensions appear to be minimal risks and anti-competition pressures towards big technology companies may be slow to emerge. As I write this article, with the announcement of a deal on Christmas Eve, Brexit has reached some form of conclusion; this removes uncertainty and gives the prospect of a more constructive relationship between the United Kingdom and its largest trading partner. To echo our words from last year – “a number of risks are alleviating.” Looking forward, on balance we continue to favour exposure to risk assets within portfolios.