Market Outlook 2021 - A Year of Healing - Holdun

YEAR IN REVIEW

I’m sure you are tired of hearing the horrors of 2020 rehashed across every media platform imaginable, so I won’t delay with the recap. A blow-by-blow recount of a year many of us wish to forget seems redundant. The recycled narrative of pandemic worries, government stimulus and vaccine optimism has been front and center for the last nine months and looks set to remain the focal point of discussions for the foreseeable future. Its repetitive nature, although somewhat draining at times, speaks to the overwhelming importance of these developments during what is an inflection point for our economy.

In a year of endless surprises, countless firsts and relentless market exuberance, a breakdown of the year in numbers may be a more digestible approach.

THE YEAR IN NUMBERS

Unrelenting waves of the virus saw the pandemic figures peak as the year drew to a close. A bleak outlook heading into 2021 was partly offset by the imminent vaccine roll-out.

Number of Daily Reported Cases and Deaths in the U.S.

Source: The visual and data journalism team bbc news, ‘Covid-19 pandemic: Tracking the global coronavirus outbreak’ (BBC News, 11 January 2021) <https://www.bbc.com/news/world-51235105> accessed 13 January 2021

Coronavirus Around the World

Source: Johns Hopkins University, National Public health agencies

Unemployment

Central to the 2020 storyline was the economic collapse following the emergence of the virus.  In the U.S., unemployment claims figures jumped by a staggering 20.5 million in April 2020 alone. To help put this into context, the largest monthly increase in unemployment figures during the Global Financial Crisis was 800,000. The worst month in history prior to this was a loss of 2 million jobs in September 1945 during WWII demobilization.

Monthly job gains or losses in the US since 1939

Source: Heather Long and Andrew Van Dam, ‘Economy – US unemployment rate soars to 147 percent, the worst since the Depression era’ (The Washington Post, May 8, 2020)  <https://www.washingtonpost.com/business/2020/05/08/april-2020-jobs-report/> accessed 13 January 2021

Stimulus

Falling revenues combined with costly pandemic relief measures and borrowing from non-financial corporates have increased global debt by an estimated $20 trillion over 2020. Global debt is estimated to have reached a record $277 trillion, representing a debt-to-GDP ratio of 365%, the highest on record.

As a share of GDP, total global debt has risen by more than 42%, compared with 2019. Of the total, government debt and private debt both rose by roughly 16%, while corporate financial debt jumped 10%.

Global Debt – % of GDP

Source: Bloomberg

Market Performance

The fastest market decline in history was abruptly followed by the best quarter for stocks in over 20 years, culminating in the largest quarter-to-quarter swing in more than 80 years. A rebound of epic proportions was made even more staggering by the fact that this historic market rally took place against the backdrop of a deteriorating economic outlook. Following the biggest tumble since 2008, stocks recorded their fastest rebound in history. The S&P 500 Index finished the year up 18.4% from a total return standpoint, while the tech-heavy NASDAQ composite index epitomized the dominance of the technology sector during the pandemic, finishing the year up 47.6%.

A Rollercoaster year for the S&P 500 Index

 

Source: Katie martin, brooke fox and fan fei, ‘Capital Markets – Follow $100 through the 2020 market rollercoaster’ (Financial Times, 21 December 2020) <https://ig.ft.com/2020-markets/> accessed 13 January 2021

Top 5 Stocks*


Sector Performance


Best

In a year where everything turned virtual, it wasn’t altogether surprising that the technology sector stole much of the market headlines. Stay-at-home winners such as Zoom and Netflix prospered amidst the pandemic induced lock-down. Tech stocks contributed a whopping 70% of the YOY return of the S&P 500 and now make up over 27% of the Index, more than double the next largest sector. A testament to its dominance over 2020.

Worst

In potentially the most bizarre market event of the year. Oil turned negative on April 21st meaning that producers were willing to pay up to $40 a barrel to get rid of a commodity that was worth almost $150 a barrel just over 10 years previous as storage issues consumed the industry. With the pandemic bringing the global economy to a halt, dwindling demand ensured that the energy industry was the most negatively impacted sector in 2020, falling 32.5%.

Tech Dominance

Source: Refinitiv

Bond Yields

The depth of concern for the stock market in early March was highlighted by the demand for US government bonds, with investors flocking to the perceived safety of Treasuries. This demand pushed valuations to record highs, culminating in the 10-year yields on US Treasuries sinking below 1% for the first time in history.

10Y Treasury Yield was Suppressed for Much of 2020

Source: Refinitiv

 

2020 Asset Class Performance

Source: Refinitiv

So, what have we learned? Amongst a myriad of lessons, both personal and financial, one sticks out from an investing standpoint. Don’t fight the Fed. In a year of unprecedented stimulus, Fed signalling became more important than ever. By pushing interest rates lower, providing liquidity and rolling out various programs to help support the economy, the Fed became a lifeline and a huge instigator of the fastest market recovery in history.

Market Outlook

Summary

  • Equities to outperform bonds
  • Long-term bond yields should rise, with the potential for a significantly steeper yield curve capped by continued low inflation and central bank support
  • The U.S. dollar will likely trend lower as a result of declining real yields and robust stimulus
  • Non-U.S. equities (with a focus on Asia) to outperform given their positioning post virus, cyclical exposure and relative discount vs. U.S. stocks
  • Continued growth within the alternatives space with private equity likely to be a major benefactor from the fixed income migration

While there is more pain to be felt short-term with record Covid cases and hospitalizations amid mandated shutdowns, the FDA approval of multiple vaccines will at some point in 2021 allow for an economic re-opening.  As a result, market participants look set to double down on their bullish stance going into 2021.

Although the economic outlook is considerably brighter, near-term risks remain.

  • A continuation of the Feds blank-check policy and an efficient vaccine roll-out are paramount if this positive market narrative is to unfold
  • Much of the positive news in markets has already been priced in. This overly optimistic market sentiment leaves investors vulnerable to negative news
  • Inflation poses one of the most significant risks to markets in 2021. Although debt growth far exceeded economic growth in 2020, the disinflationary effect of the pandemic is likely to mute any imminent inflation surprise

Equities

With an economic recovery now on the horizon, we foresee a positive trajectory for stocks in 2021. Despite record-high valuations, an environment of low-interest rates, Low inflation and monetary and fiscal support should see equities continue their upward path in 2021, albeit through slightly different avenues.

Market rotation

Towards the end of 2020, more cyclical drivers of the global economy began to outperform the mega-cap Covid winners as vaccine hopes intensified. Value, after a 10-year hiatus, was back in focus.

As a global recovery takes shape, we feel that more cyclical exposure is called for to take advantage of strong operating margins. A rotation away from the big stay-at-home winners that dominated markets during the pandemic into established value stocks that have underperformed will ensure there is more room to run from a valuation standpoint. While near-term economic damage from the virus may limit the ability of these cyclical value-oriented sectors to sustain their current pace, we believe many of the more established value names have the potential to outperform over 2021.

Although large-cap stocks stole much of the limelight in 2020, the likelihood of a mean reversion, closing the performance gap between large and small-cap stocks, increases as economies re-emerge. Small-cap stocks offer lower relative valuations, growth potential, and an avenue to avoid the regulatory risks that seem to be building in the mega-cap tech space in the U.S.

During times of stretched valuations, one of the best things you can do is look to international markets for stocks that have yet to be rewarded, offering a discount relative to U.S. equities. Europe, for example, offers more cyclicality than the U.S., which will be a tailwind if the above-mentioned sector rotation takes hold.

Emerging markets, specifically Asian markets, appear to have handled the pandemic better than their western counterparts and look to be in better shape heading into 2021. Their focus on technological production and healthcare has ensured that these regions are positioned particularly well, and with a U.S.-China reset likely under the Biden administration, we favour assets exposed to Asia/China growth.

Fixed Income

Recent monetary stimulus has created a challenging landscape for fixed income, with Treasuries offering interest rates close to zero, all but eliminating their upside potential. Going forward,  Assuming a path to stronger economic growth through the second half of the year, we envision a steepening of the yield curve, with the yield on 10Y Treasuries perhaps approaching 1.6% (up roughly 65bps from the December average).

The diversification and capital preservation benefits of these safe-haven Treasuries has not gone away, but longer-term investors may want to be underweight traditional fixed income as the economy re-emerges, opting instead for alternative investments such as private equity and real estate to generate acceptable returns while still availing of adequate portfolio diversification.

Alternatives

From fine wine to art, wind farms to venture capital, alternative investments have become less ‘alternative’ over the years. From 2007 to 2020, the alternatives market has more than tripled, increasing from $2.5 Trillion to over $10 trillion and is expected to reach $14 Trillion by 2023. Recent record-high equity valuations combined with historically low interest rates looks set to function as a catalyst for further growth in the space.

Private Equity 

With access to private funding increasing, companies will continue to pursue their business objectives without the costs and distractions associated with operating in the public spotlight. More than ever before, the rapid growth companies experience, and the value created by that growth is occurring pre-IPO (initial public offering), creating ample opportunity within the private equity space.

With the pandemic functioning as a significant disrupter to the traditional asset allocation approach, private equity looks set to benefit from the migration away from low yielding fixed income, operating as a growth enhancer for institutional and retail investors alike.

Commodities:

Safe havens such as Gold continue to be bolstered by U.S. dollar weakness going into 2021. Despite being the best performing established asset class in 2020, valuations still have room to run as declining real yields and robust stimulus weigh on the Dollar.

Conclusion

In Short, risk assets still have room to grow, but investors should be careful not to overreach for risk. While much of the outlook for equities is positive, a repeat of the returns experienced in 2019 (31.5%) and 2020 (18.4%) is unlikely.

The S&P 500 has rallied 72.4% since the start of the bull market on March 23rd, 2020. With much of the positive factors already priced into markets, each incremental move higher will become increasingly difficult to justify. Reducing your portfolio exposure to last year’s big winners will help minimize downside risk, while exposure to value, small-cap, international stocks and alternatives will offer greater upside potential and vital diversification benefits.

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