After such a dramatic year, it is astonishing to reflect that global equities will finished up by over 10% having at one point fallen more than 26% in Sterling terms. While much of the rise from April was driven by government and central bank stimulus, the strong final quarter was accountable to the series of vaccine approvals which allowed investors to look through the short-term disruption and focus on a return to normality in 2021.
We share the view that economic momentum should build through 2021, particularly in developed markets where economies have been hardest hit, as the rollout of vaccines allows restrictions to be lifted gradually, and enable a far more complete return to normality than was previously anticipated. Not only can there be catch-up growth from a return to pre-COVID levels, but there has also been an accumulation of pent-up demand from households (who have generally been unable rather than unwilling to spend) and significant amounts of government spending are anticipated. In this positive scenario, where successful vaccine rollouts occur and no further issues arise, we believe that 2021 could be finishing with a period of hot economic growth.
Clearly, such a smooth exit from this pandemic is not without its risks. The recent variants discovered in the UK and South Africa are a testament to this. There may also be logistical or medical issues with the vaccine rollout which are yet unknown. However, we consider that the path over the full course of 2021, even in light of the recent lock down, will be towards lower restrictions, akin to easing off the brakes.
It is important to consider that better economic growth does not necessarily lead to strong equity market returns. Current valuations suggest that the optimistic outlook is already priced into markets to some degree. However, analysts’ earnings estimates will have lagged this better outlook and there will be further scope for upward revisions through 2021, which will allow markets to grow into their valuations to a certain extent. This is not to say that equities are a clear buying opportunity, but in the wider picture of very low-interest rates, they may continue to find buyers at higher levels.
The longer-term outlook also has the potential to be significantly different from the recent past. Such extreme disruption has the potential to drive innovation, as well as the destruction that has occurred. There are also geopolitical shifts, predominately between China and the US, that will influence trade and investment for many years, likely leading to a permanent shift in supply chains. We also believe that there is a significant chance of higher inflation in the medium term, which presents opportunities as well as clear risks to portfolios’ real value.
Political risks that have been so significant over the last several years have the potential to be moderated over the coming twelve months. The resolution of the Brexit saga, ending in a deal that appears broadly satisfactory to both sides, should lift the heavy cloud that has been hanging over the UK economy and investments. At such an extreme discount, a change in external investment flows into UK markets could lead to a period of outperformance for UK equities, breaking a multi-year streak of underperformance. In the US, the victory for Biden in the Presidential elections may lead to more predictable policy-making and allow markets to focus on fundamentals rather than tweets.
While there may be other events and risks, the path of returns is likely to be overwhelmingly influenced by the progress of the vaccine rollout and any change in the spread of COVID. However, we are hopeful that this becomes a diminishing risk over the course of the year.