This December 2020/January 2021 market update is brought to you by LGT Vestra
We began 2021 as we ended 2020, facing further restrictions as a result of the pandemic. However, there is a sense of hope that this lockdown may be the last, following the rollout of the various vaccines.
Whilst President Trump continued to dispute the election, and protestors invaded the Capitol, Congress confirmed Joe Biden’s victory. In the Georgia runoffs, the Democrats managed to secure control of the Senate by the narrowest of margins.
For the UK, a post-Brexit deal was finally agreed on Christmas Eve, but much is yet to be decided about the UK’s future relationship with the EU, particularly concerning financial services.
In the US, Congress finally passed a bill approving a $900bn stimulus package. Following the two run-off races in Georgia, the Democrats have now secured the Senate in addition to the White House and the House of Representatives for the first time since 2009.
This means President Biden should have the support he needs to pass legislation during his first two years in office, before the mid-term elections could upset the balance in the Senate.
Following the invasion of the Capitol by protestors, the House of Representatives have impeached President Trump for a second time. However, this had little market impact, as his remaining time in office is so short.
The expectation of higher spending by a Democratic controlled government supported equities but weighed on the treasury market. We expect President Biden’s priority to be fighting the pandemic and providing stimulus to support the economy in his first weeks in office.
The UK and EU finally announced a post-Brexit trade deal, with just seven days of the transition period left, and after eleven months of negotiations. The UK compromised on fishing and other areas in order to get a deal done.
This is a big step in developing a post-Brexit relationship between the UK and EU, but it is not the last. The Christmas Eve deal does not include financial services, which are currently subject to further negotiation, and will depend on the EU’s judgement regarding the “equivalency” of regulations.
Whilst tariff-free trade has been agreed in many areas, it is not going to be as free as it was pre-Brexit, nor will it be without its cost in terms of additional paperwork and administration.
The lack of enthusiasm from UK markets and the pound, following the Brexit deal announcement, may well be due to what is not in the agreement, as well a reaction to the new variant of the COVID-19 virus.
With the national lockdown likely to be in place until at least the end of February, Chancellor Rishi Sunak announced a further £4.6bn support package for UK businesses, particularly for those most affected in the retail, hospitality and leisure sectors, and the furlough scheme has been extended to March 2021.
The FTSE 100 Index has started the year on a firm footing as a result of the vaccine and the removal of some of the uncertainty around Brexit. The energy and materials sectors found particular support from the prospects of an economic recovery.
Looking ahead, the prospects for further fiscal support, and the wider rollout of vaccines is expected to continue to support equity markets. While bond yields have risen, we expect central banks to continue to keep rates low for a prolonged period of time.
We continue to favour companies with attractive long-term growth prospects, robust business models and strong balance sheets. These companies are likely to continue to perform well over the long-term and remain supported by low interest rates.
Market View Changes
US Inflation-linked Treasuries: ▲ to ◄►
US dollar ◄►
The dollar has shown itself to be a safe haven currency throughout the pandemic. We have seen the dollar give back some of this strength as investors price-in a global recovery; however, looking forward the dollar is likely to balance the rise in cases, fiscal policy, and the rollout of vaccines.
The euro has been supported given the announcement of a mutual fiscal programme but rising cases have brought short-term concerns.
Following an initial rise after the announcement of the Brexit deal, sterling has remained relatively subdued given the spread of the new variant of the virus and the renewal of lockdowns and further restrictions. We expect the pound to remain range-bound as investors consider the prospects for growth in the UK; balancing the cost of restrictions in the short-term, with the vaccine improving the outlook for jobs and growth over the medium-term.
Government bonds Conventional Inflation-linked
UK Gilts ▼ ◄►
US Treasuries ◄► ◄►
German Bunds ▼ ◄►
The pandemic has resulted in near zero interest rates across the developed world. Given the pushback on negative interest rate policy and the potential recovery later this year, gilts offer little value.
Short-term inflationary exposure is a slightly more attractive investment, given their ability to protect should inflation rise as economic activity recovers. US Treasury yields have risen since the start of the year, as supply is likely to increase under the Democrats; however, prices have moved rapidly and could correct if the economic outlook deteriorates.
US Treasury Inflation Protected Securities have outperformed conventional Treasuries as inflation expectations have risen materially. Following this move we have removed our outright positive view, but believe they remain a useful diversifier within portfolios.
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.
UK equity ◄►
The FTSE 100 index has started the year strongly, buoyed by its exposure to energy and materials. At the end of last year, following the positive news of the approval of the COVID-19 vaccines, companies in these sectors saw renewed interest. This trend has carried on into the New Year.
Many businesses in these hard-hit cyclical sectors have seen their share prices rise. The market continues to trade at valuations that look cheap relative to markets elsewhere in the world, which has spurred some takeover interest, given the opportunity to pick-up companies at discounted prices.
However, the surge in COVID-19 cases, driven by the new more virulent variant of the virus, and the lack of Brexit deal for the service sector may weigh on sentiment. We thus find it hard to justify anything more than a neutral stance for the time being.
Europe ex UK equity ◄►
The approval of the proposed EU pandemic recovery package saw a landmark step towards much needed debt mutualisation across the Eurozone and bolstered the euro as a potential reserve currency.
However, its implementation was delayed and raises questions of how effectively this will raise growth rates across the Eurozone. So far, on aggregate, the vaccine rollout has been slower in Europe than in the UK and the US.
The ever-present divisions reared its head with Italy, with the Italian government set to collapse. Hence, we retain our neutral stance on European equities.
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 meteoric rise in Tesla’s share price, as well as 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 has resulted in a rotation out of these stocks, this does not change our longer-term preference.
Japan equity ◄►
Whilst we recognise that Japanese equities rebounded strongly as investors have become more confident in a global recovery, we still prefer broader Asian exposure than country-specific exposure to Japan.
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.
Asia ex Japan equity ▲
Although the initial coronavirus outbreak was reported in China, they are one of the few countries to have grown in 2020. 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 and regulatory moves against Alibaba are a reminder of the governance and regulatory risk that goes with investing in China. Pent-up global demand is likely to boost prospects for the region in the coming months.
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.
On the vaccine front, they are likely to inoculate their populations later than more developed economies. 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.
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 2020, although offering some degree of protection. Our preferences, however, remain the same; favouring “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.
The latter half of 2020 saw increased corporate activity and IPOs, which was well captured by these funds. Event driven strategies should continue to do well as we expect the pace of corporate activity to remain elevated. However, we continue to stress the importance of finding the right vehicle and investment manager in this space, which requires extensive due diligence on the strategy and fund.
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 prefer 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.
We expect demand for high quality office and retail space in city centres to recover from 2022 onwards; however, we are more cautious about space for back office functions, where demand is likely to be undermined by new technology.
The impact of COVID-19 on future property demand remains ambiguous; therefore, it continues to be important to be selective and not chase the otherwise attractive yield when investing in this asset class.