18 December 2020
GAM Investments’ Charles Hepworth and James McDaid reflect on a remarkable 2020 and discuss why they believe equities offer long-term return potential as societies and markets revert to pre-pandemic norms.
This year has clearly been a challenging one for investors. Deciding to hold one’s nerve in the depths of the March selloff was a tough decision, but one that paid off. As we saw stimulus efforts from central banks gather pace and liquidity floodgates open, the market tone quickly changed at the end of March. Investors who capitalised in April on the falls in equities and parts of the fixed income market certainly benefited. In our view, the likelihood of simply using passive market exposure and expecting continued solid returns is looking increasingly risky as we move into 2021. We believe stock and sector selections will be even more critical – we have seen the sharp difference this year between the growth tech stocks and value styles in terms of performance. Next year these value styles will no doubt come back to the fore, as we have witnessed recently.
We have seen the damaging effects of lockdowns and shutting parts of the economy on economic growth across the world. This was unprecedented. However, equally unprecedented was the ability of central banks to swiftly change the market narrative by flooding the world with liquidity, changing their asset purchase rules and bolstering stock markets. For now, it seems central banks have done as much as they are willing to do. However, should markets wobble again, it is likely central banks will intervene once more. Equity markets have bounced remarkably quickly from the lows in March (faster than a normal recession) as central banks went all in. What markets need to see now is clear earnings evidence from companies going forward. We believe this will make investing more of a stock picker’s market in 2021, compared to the broad beta-driven market that has dominated the course of 2020.
An excess of fiscal and monetary stimulus should lead to a higher amount and flow of money in the system (ie money velocity). All things being equal, this would lead to higher inflation under the classic monetarist financial equation of money quantity x money velocity = notional GDP. Right now, it is not a short-term story as money velocity has collapsed this year (by close to 20%) but two years out, can we be confident there will be no inflation? Probably not. We believe sovereign debt could be a poor investment as the only thing governments are guaranteeing is currency debasement under this scenario. Real assets, commodities, property but also equities still offer the better long-term returns in this scenario, in our view.
Over USD 6 trillion has been added to central bank balance sheets this year, compared to the USD 3 trillion added in 2008 and 2009. The Federal Reserve (Fed) alone has added over USD 3 trillion and the US stock market capitalisation has increased by a similar amount. Added to this central bank stimulus, fiscal injections mean overall global policy stimulus now stands at USD 18 trillion. Global equity markets have increased more than USD 15 trillion since the March lows. While the pandemic has been awful and recession alarms have fired off – the size and scale of the response has been the one thing bolstering markets. It feels alien to invest in this environment when the global economy is faltering but fighting this size of policy stimulus is a losing battle.
Turning to the growth outlook, the International Monetary Fund (IMF) estimates that world output will fall 4.4% this year compared to growth of 2.8% in 2019. The IMF’s latest outlook for 2021 is for a bounce of 5.2%. This should be taken with a pinch of salt as it is based on successful containment of Covid-19. Vaccine success is likely to have some impact on these numbers, but there is the large issue of producing and distributing worldwide to eight billion people. Our estimate is for at least one billion people vaccinated by the middle of 2021 - markets are already pricing this in, so any delays to this timeline will only disappoint. Vaccinations will principally be in western economies, so their recovery should be even stronger into next year. Service sectors should be key beneficiaries as we return to a more normal way of life. We have recently seen sharp rallies in the beaten-up cyclical and value styles and this can be expected to continue.
In the US, we have come to the end of an erratic administration and will be returning to an old-school style presidency. We now have a markedly reduced chance of the destruction of the old-world order which we were seeing under Trump. The move back towards global institutions must be a positive for the global trading system. As for China relations, a reversion of all of Trump’s trade tariffs is unlikely given the domestic political backdrop. Instead, we expect Biden will opt for a strategic review of the relationship, engaging more with multilateral organisations. This should nonetheless help reduce headline volatility and fears of de-globalisation. However, do not expect a Biden administration to welcome China back with open arms – it will just be a partial return to the status quo that existed pre-Trump. On trade policy, we should expect Biden to strike a more strategic, multilateral approach, notably improving relations between the US and European allies.
Turning to Brexit, it remains uncertain whether we will get a deal or the UK Prime Minister Boris Johnson walks away empty handed. Johnson remains committed to his views and is unwilling to budge to secure a Brexit deal, and is instead holding out for Europe to blink. It is increasingly difficult to follow this perilous line of thought, especially so now that President-elect Biden will crush any hopes of a UK-US trade deal should Johnson backtrack on the controversial ‘Internal Markets Bill’. We expect the likelihood of a no-deal outcome at this late stage to be a small tail risk probability. The more likely scenario is a cobbled together and compromised deal which sees the UK in effect become a satellite of the eurozone - not wholly tied to it but still largely influenced. Sterling will likely rally somewhat against the euro as a level of uncertainty is removed, but longer term it is unlikely to have continued momentum. Of course, there is also a very small chance that a further transition period is agreed to under the guise that a departure during a pandemic is not the most sensible of political acts. As usual, from a market perspective, the continual committing of self-harm is not a rewardable act as far as investors are concerned and UK risk assets remain still largely unloved and ignored.
All in all, we believe it is possible to capture further upside from equities from here, even if markets are hitting all-time highs. We are living in a new normal with the associated strange social norms now the order of the day. This also applies to the investment universe. Central banks have taken control of the growth narrative and to our minds it would be foolhardy to bet against that and even foolhardier to expect things not to be back to pre-pandemic norms by the middle of 2021.
The information in this document is given for information purposes only and does not qualify as investment advice. Opinions and assessments contained in this document may change and reflect the point of view of GAM in the current economic environment. No liability shall be accepted for the accuracy and completeness of the information. Past performance is no indicator for the current or future development. The mentioned financial instruments are provided for illustrative purposes only and shall not be considered as a direct offering, investment recommendation or investment advice.