
Volatile markets are here to stay as 2021 begins
This November/December market update is brought to you by LGT Vestra
This year has been a turmoil of events; while many of our experiences of COVID-19 were the lockdown restrictions affecting our lives, it is important to recognise the tragedy of 1.6 million people who have died globally because of the virus.
We started the year off on a firm footing, to then be hit hard by the pandemic and the unprecedented events that followed the outbreak of the coronavirus and the national lockdowns experienced globally. We are, however, looking to end the year on a more positive note again with vaccines in focus.
The flow of news has been unrelenting, with significant economic and market-related developments occurring on an almost daily basis. It is no surprise, then, that the dispersion of returns between different geographies, styles, sectors and asset classes has been extraordinary.
The more vulnerable members of society and health workers have already started receiving vaccinations. However, manufacturing and distribution of the vaccines at scale will take some time, and it may not be before mid-2021 when the other vaccines become widely available, to help ease supply.
There is some much-needed light at the end of the tunnel, and life should gradually return to ‘normal’. In the meantime, the virus continues to spread and measures to counter the pandemic may be in place in one form or another for much of next year. As a result, it is still too early to be tightening financial conditions, and a continuation of the coordinated support, from both fiscal and monetary authorities, is still needed to prevent long-lasting economic damage.
President Trump’s legal efforts to overturn the election result was in vain, as the electoral college confirmed Joe Biden as the President-elect. Joe Biden’s campaign and nominations for key posts give us a clear idea of the direction he expects to take. One appointment worth highlighting is Biden’s nomination for Treasury Secretary is former chair of the Federal Reserve (Fed) Janet Yellen. Yellen will no doubt want to give the Fed as many tools as possible, enabling it to provide continued support to the US economy as it recovers from the pandemic.
Some of Biden’s early initiatives will likely include re-joining the World Health Organisation and the Paris Accord on climate change, as well as increased spending on environmental projects. Should the Democrats fail to gain control of the Senate, Biden’s spending plans and proposed tax rises may be diluted. However, a more measured approach to diplomacy should still be welcomed by markets that dislike uncertainty.
Some things stay the same; there has been little visible progress on a post-Brexit trade deal with the three key sticking points remaining unresolved. The first is the so-called ‘level playing field’ and whether the UK should continue to stick to EU rules on issues like workers’ rights, environmental regulations and state aid. The second is governance, to ensure both sides keep to any deal. And finally fishing, with the EU wishing to retain access to UK waters for EU fishermen.
Even if these issues are resolved, the agreement would still need approval by each individual state, which may yet prove problematic. Boris Johnson warned that there is a ‘strong possibility’ no agreement will be made, but insists this is not necessarily ‘a bad thing’. That said, both sides have agreed to ‘go the extra mile’, and talks continue.
In the event of a no-deal Brexit resulting in World Trade Organisation terms, tariffs would be introduced on goods traded between the UK and EU. The concern, however, is less about the cost of the tariffs, but the administrative burden and the potential disruption this would bring.
Despite such an eventful year, many equity markets have hit all-time highs; a poignant reminder that keeping calm and carrying on investing during volatile times has proven to be the right strategy. Looking ahead to 2021, volatile markets are here to stay, but risk-assets should remain supported by low interest rates and a gradual return to normality.
Market view changes
No changes
Currencies
US dollar ◄►
Sterling ◄►
Euro ◄►
The dollar has shown itself to be a safe haven currency through the pandemic. As investors weigh the future outlook for growth, the pandemic and interest rates, we will continue to see the dollar swing versus a broad basket of currencies.
While the euro had been supported given the announcement of a mutual fiscal programme, its implementation has been delayed by infighting.
Sterling remains a function of the ongoing trade negotiations and the subsequent prospects for growth in the UK. We expect the pound to be volatile as we go through the final stages of the Brexit negotiations.
Fixed income
Government bonds Conventional Inflation-linked
UK Gilts ▼ ◄►
US Treasuries ◄► ▲
German Bunds ▼ ◄►
The pandemic has resulted in near zero interest rates across the developed world. As outright government bond yields are close to record lows, we would caution that our views are more reflective of a relative attractiveness rather than a long-term view.
Given the political and economic uncertainty facing the UK, gilts do not appear to price in this uncertainty and hence we retain our negative view. Short-term inflationary exposure is a slightly more attractive investment given their ability to protect should negotiations falter.
US Treasuries have rallied materially since the start of the year but should the situation deteriorate, the Fed is likely to loosen policy further. Inflation exposure remains a useful diversifier.
At current valuations, we cannot justify investing in conventional German bunds and retain our negative stance but see some scope for inflation to pick up over the medium term in light of fiscal stimulus.
Investment grade corporate bonds ◄►
With central banks rushing to support this vital market in order to avoid further economic damage, credit spreads have retracted from their widest point in March. The market now trades at similar levels to where they were a year ago, albeit with much more dispersion given how COVID-19 has affected certain sectors so dramatically. We moved the arrow to positive earlier this year to reflect the high degree of compensation available and the actions undertaken by companies to preserve cash.
As spreads on offer are now meaningfully lower, we have moved the arrow back to neutral. This move reflects the support that central banks continue to offer the market, albeit with much less attractive yields on offer, thus tempering our enthusiasm.
High yield credit ◄►
The wave of defaults that investors expected at the onset of the pandemic has thus far failed to materialise given the broad-based support that governments and central banks have provided.
While defaults were concentrated in the heavily affected retail and oil segments, the intervention of the Fed into exchange traded funds and newly junked bonds has seen liquidity conditions of highly indebted companies remain loose.
This has supported the market, however, questions remain on balance sheet strength should there be a choppier economic recovery. Hence, we retain our neutral stance but stress selectivity.
Emerging market debt
Local currency denominated debt ◄►
Hard currency denominated debt ◄►
Whilst emerging markets typically benefit when the US loosens monetary policy and the headwinds from a stronger dollar fade, the concern is their ability to respond to further outbreaks of the virus, and the resilience of their economies to cope with the restrictions. Hence, selectivity remains as important as ever and we retain our neutral stance across this diverse asset class.
Equities
UK equity ◄►
The FTSE 100 index has underperformed many of its developed market peers this year, as it has less exposure to high quality growth companies and more exposure to energy and financials. Following the positive news of the vaccine, these companies saw renewed interest.
That said, the UK has traditionally been supported by high dividend payments, and these have been substantially cut during the pandemic. However, as a market that has been shunned by international investors, deterred by the Brexit uncertainty, it trades at valuations that look cheap relative to markets elsewhere in the world. This has spurred some takeover interest, given the opportunity to pick-up companies at discounted prices.
Overall, however, we find it hard to justify anything more than a neutral stance for now.
Europe ex UK equity ◄►
The approval of the proposed EU pandemic recovery package to be deployed next year was a landmark step towards much needed debt mutualisation across the Eurozone, and bolstered the euro as a potential reserve currency.
The details have been debated for some time and were held up by Hungary and Poland. After the EU managed to tweak the terms of the deal and overcome the objections, the budget has finally been cleared.
Whilst this is welcome news, the ever-present divisions within the Eurozone suggests further progress in this direction may be difficult to achieve. We therefore retain a neutral stance on European equities; however, we will continue to monitor the situation, and review our stance as we begin to see the eventual implementation of the stimulus package.
US equity ▲
The US remains the market that we consider home to the highest quality companies that have both held up well during this turbulent time, and whom we believe can sustainably compound growth over the longer term.
We continue to favour these companies, with robust balance sheets in less economically sensitive areas. Many have the ability to come out of this global crisis stronger, with fewer competitors, and the ability to use their cash for tactical M&A.
The extremely successful initial public offerings (IPO) of DoorDash and Airbnb prove that the market is home to uniquely innovative companies, but also demonstrates the high expectations that investors have for these companies.
Whilst we stress that certain US stocks have become rather expensive, and news regarding the vaccines have resulted in a rotation out of these stocks, this does not change our longer-term preference.
Japan equity ◄►
Yoshihide Suga, Shinzo Abe’s replacement as Japan’s Prime Minister, has pledged to continue the economic policies of his predecessor. In general, Japanese companies have plenty of cash on their balance sheets and should be able to weather the storm.
Dividends have been cut in Japan, but not to the same extent as in many other regions. Whilst valuations are attractive, the headwinds from US-China tensions, and the export-driven nature of the market leave us to retain a neutral stance for the time being.
We prefer wider Asian exposure rather than country-specific exposure to Japan.
Asia ex Japan equity ▲
Although the initial coronavirus outbreak was reported in China, they are one of the few countries expected to grow this year. Vast testing infrastructure has helped to supress minor local outbreaks, and life has largely returned to normal.
The suspension of the $37 billion Ant Group IPO, however, is a reminder of the governance and regulatory risk that goes with investing in the region, and China in particular.
Many countries in Asia have come through the pandemic better than countries elsewhere, the valuations look relatively attractive and the prospects for long-term growth are substantial, hence our positive stance.
Emerging markets ex Asia equity ◄►
The difference between many emerging market economies remains stark; some are likely to be resilient, whilst others are likely to suffer. The robustness of their respective healthcare systems and the speed of government action is likely to determine how these countries fare.
Whilst we recognise that current headwinds are significant, the long-term growth prospects for many emerging markets continues to be high. We maintain our neutral stance and continue to stress selectivity in this diverse region.
Alternative investments
Hedge funds/targeted absolute return
We have no arrow for the hedge funds/targeted absolute return space to reflect the varied nature of these investments. Many absolute return funds have sensitivity to equity markets, and this caused many funds to sell-off at the same time as equity markets in March, although offering some degree of protection.
Our preferences, however, remain the same; preferring ‘event driven’ strategies due to the fact their payoff structure is difficult for us to replicate with long-only funds, and they provide decent uncorrelated returns to the markets.
However, we continue to stress the importance of manager selection in this space, which requires extensive due diligence on the strategy and fund.
Property
We have also adopted no arrow for property, to reflect the high degree of diversity within the space, and the difficulty of investing in property funds.
Whilst we acknowledge the yields on offer may look attractive relative to other sources of income, the property market remains challenged, particularly the retail and office segments. We continue to suggest that any exposure to property should be selective and favour closed-ended over open-ended vehicles, given the liquidity mismatch.
The accelerated trends towards online shopping and working from home have clouded the outlook for commercial property. Although news of the vaccine has caused a reassessment of property investments, the longer-term trends still apply.
Office rents are likely to remain under pressure until businesses decide how to balance the desires to work more flexibly, with the benefit of having employees collaborating in an office environment. Therefore, it continues to be important to be selective and not chase the otherwise attractive yield when investing in this asset class.