The ringing in of the New Year provides us an opportunity to reflect on what was an unimaginable year in 2020 – forever to be remembered for the COVID-19 pandemic, the worst global health crisis in more than a hundred years.
A second wave of the health crisis is currently gripping the world with many regions, including large parts of Canada, re-imposing strict lockdowns to curb the spread. This is a stark reminder that the crisis is by no means over. The virus’ evolution in 2021 will ultimately dictate the path forward for the global economy and capital markets, and thus influences much of our outlook.
On a positive note, science has provided us with more than just a glimmer of hope with the development of multiple effective vaccines. The shortest investment time horizon our multi-asset team tends to focus on is 12-to-18 months and this positive development may put an end date to the global pandemic within that timeframe.
It’s with this lens that we look through the very real near-term risks to the economy to focus on longer-term optimism and an economy that has proven quick to adapt to the rapidly changing circumstances. The rollout of effective vaccines will not only save lives but also curb the effects of the pandemic on economic sectors which have been most impacted by the associated lockdowns, opening the door for more sustainable growth in 2022.
Stock market performance ≠ economic performance
The global pandemic has pulled forward the realization of several prominent secular themes and one such theme is digitalization. It is clear when looking under the proverbial hood of the stock market. Year-to-date (as of December 22nd) the NASDAQ Index is up a surreal 42% in a year where the International Monetary Fund expects the global economy to contract by 4.4% (as per its most recent forecast) – a figure that rivals the global financial crisis.
The biggest contributors to this disconnect between the economy and stock markets have been the best performing stocks of much of the last decade along with some new ones: Apple, Amazon, Microsoft, Tesla, Nvidia, Facebook, PayPal, Alphabet (Google), Netflix and Shopify. Meanwhile, sectors such as airlines, department stores, real estate and travel and tourism remain down significantly since the beginning of the year. The fact that the above-named securities started the year as much larger components of the overall stock market than the struggling sectors is the primary reason the stock market has so significantly outperformed the economy.
We think there will be room for some of these outsized gains to revert as the pandemic recedes and we have started positioning our portfolios to capitalize on these potential opportunities – many of which are found outside of the U.S. stock market in both international developed and emerging markets.
Coordinated policy maker support
Another theme that has been pulled forward by the pandemic is a move towards greater coordination between monetary (money supply and interest rates) and fiscal (government spending) policy. A seemingly open-ended commitment by central banks to support the greater issuance of debt by governments (to ensure the smooth flow of capital) in support of the pandemic relief may open the door for further coordination in both normal times as much as in crises.
The U.S. Federal Reserve moved its goal posts as part of this shift, making explicit its willingness to allow for higher inflation should it materialize and easier monetary policy later into the economic cycle to allow for maximum employment. This is partly why we enter the year expecting the yield curve to steepen (growing differential between short- and long-term bond yields) as bond yields rise moderately at the long end of the curve while short-term Treasury yields remain at the low levels central banks have repressed them to.
This theme also underpins many of our strategic expectations where the overall potential return on stocks relative to bonds remains attractive both in the short and long term. Although on many metrics stock markets are expensive relative to history, the extreme lows in bond yields make bonds even more expensive on a relative basis.
Taking a stance with currencies, commodities, and inflation
Our perspective on policy makers also influences our view of the currency market. The U.S. dollar has continued to weaken in recent months following the sharp appreciation experienced at the height of the crisis as financial conditions tightened and capital flowed to the deepest, most liquid markets (the flight-to-safety as the industry calls it). We see scope for this trend to continue as the U.S. dollar remains relatively expensive, preferring to short the U.S. dollar relative to higher volatility currencies including the Canadian dollar and the Euro.
Commodity markets have regained some resilience supported largely by the strength of China’s economy and large parts of fast-growing Asia, the most influential of commodity consumers. Energy demand should continue to recover as we move beyond the impact of the virus and there is room for oil prices to surprise more meaningfully to the upside due to supply constraints. As investment in the industry had already significantly declined prior to the outbreak, the old adage that short-term supply gluts create long term supply shortages may again prove true.
Much of our view would indicate that inflation should rebound, and we do believe this is the case. However, it is important in this context to differentiate a rebound in inflation versus a structural case for higher inflation. Prospects for inflation were muted prior to the onset of the crisis and we currently do not see the pandemic’s impact as being able to change what was otherwise a structural trend towards low inflation.
Other factors that have come to prominence this year is the so-called democratization of the stock market through commission-free trading platforms. With this trend, we even saw speculators propping up bankrupt stocks. There has been a continued widespread interest in cryptocurrencies like Bitcoin, which declined more than the global stock market at the peak of the crisis only to recover close to 400% (as of December 22nd). It remains to be seen whether such a volatile instrument can truly be considered an alternate currency, but one thing is for certain, it has not ceased to intrigue.
The best plan is to have a plan
Overall, we continue to anchor on our long-standing approach to managing portfolios and advice to our clients. Have a financial plan. Ensure your portfolio is diversified and robust enough to face multiple market environments, both good and bad. Remain dynamic to the ever-changing prospects for capital markets. And take advantage of emerging longer-term opportunities, like private equity and real estate, where and when it makes sense within an investment strategy.
Looking back at 2020, it was a good year for investors despite the pandemic. It is important now to understand what is behind us, and what is priced in, as much as we position for what is ahead. With that, and like many of you, I am very much looking forward to 2021 and the hope it brings for our collective health and prosperity.
The above information should not be construed as offering specific financial, investment, foreign or domestic taxation, legal, accounting or similar professional advice nor is it intended to replace the advice of independent tax, accounting or legal professionals.