After the dramatic events of 2020 the social and economic uncertainties stemming from the COVID-19 pandemic will not suddenly subside but from an investment perspective, 2021 could see a return to relative normality with a number of key uncertainties resolved.  Challenges will remain though and the unexpected is always a concern but the support provided by governments and central banks around the world appears to have carried economies through the worst of the crisis and vaccines provide hope that an end is in sight, giving policy makers the opportunity to deploy further economic stimulus measures.

2020 Year in Review

Although 2020 was a terrible year in many ways, it was surprisingly kind to most investors with diversified portfolios, the UK being one of the few global stock markets to fail to produce gains Led by the technology sector, the US market ended the year around all-time highs, this reflected an acceleration of key structural trends for workers and consumers, including the adoption of remote working and a substantial increase in online retail.

Unlike the credit crunch in 2008/9, it seems that lasting damage has not been done to consumers, the ability of businesses to supply them and of banks to provide finance. Rather, the costs have been picked up by governments and central banks in the form of unprecedented levels of fiscal and monetary stimulus. Markets viewed the accumulation of greatly increased levels of debt as an issue to be dealt with in the future.

2020 Market Returns

Stock Market Index/Asset Total Return (GBP)
 MSCI Europe2.13%
 S&P 500 (US)14.12%
 FTSE All Share-9.82%
 MSCI Emerging Markets14.65%
 TOPIX (Japan)9.14%
 Gold17.21%
 UK Government Bonds (Gilts)8.27%

 

2021 Outlook

The key reason for optimism that 2021 can see sustained recovery, is the rapid rollout of COVID-19 vaccines which will allow an easing of social restrictions and then hopefully some return to normality.  Provided mass vaccination programmes proceed effectively, this should see the more vulnerable groups in developed economies inoculated in the early part of the year, allowing the end of the most onerous lockdown measures as the remaining populous are vaccinated.

From an investment perspective, this should allow the sectors most impacted by the pandemic, services for example which have suffered disproportionately from social distancing restrictions and areas sensitive to global economic growth such as natural resources, to recover.  An indication of this has been seen with the much stronger performance from these type of companies following the announcement of effective vaccine development in November.

The UK and Europe are more tilted towards these areas while the US market is less reliant and relatively more expensive given the heavy weightings to technology.

This led to a much wider than usual divergence in returns between sectors in 2020.  A more balanced return across different styles, sectors and regions seems likely in 2021 as economic recovery gains momentum. Natural resources companies for example should benefit from increased demand, although some of the more traditional industries will face challenges, for example the accelerating shift to clean energy may compromise prospects for the oil industry.

The areas seeing the strongest growth in 2020, mainly technology related, should continue to benefit from the ongoing change in behaviours, but the high value placed on these companies could be assuming a permanent shift, which may not prove to be the case if the pandemic constrained environment in which they have prospered, fades away.

Far Eastern economies have generally been the most successful in containing the pandemic, resulting in more rapid economic recovery and less need for monetary and fiscal stimulus. China is already exceeding pre-crisis levels of activity and was the only major economy to see economic growth in 2020.  With fast growing consumer populations benefiting from rising incomes, lower levels of debt than the developed world and relatively attractive stock market valuations, emerging Asian economies including India and China may be well placed to prosper in the next decade as domestic demand increases, along with the usual strong export levels.

Other Themes

The political scene in 2021 should also prove to be more benign than recent experiences. As Donald Trump’s presidency ends the incoming Biden administration is expected to follow a more conciliatory approach to domestic and foreign affairs.

With the Democratic Party now controlling both Houses of Congress following the Senate elections in Georgia, there is the possibility that less business friendly measures such as higher tax rates and regulation of technology giants could be introduced. Further fiscal stimulus along with ambitious infrastructure plans and clean energy/climate change packages, as Trump’s climate and environmental policies are undone, should provide an economic boost however.

The conclusion of a trade deal between the UK and EU has avoided significant disruption and although it is too soon to tell what the longer term impact of the UK’s exit from the EU will be, the removal of uncertainty should be a positive for the UK stock market, which may also benefit from sustained economic recovery due to the relatively high proportion of more economically sensitive companies such as natural resources and banks, contained within the index.

The challenge of tackling climate change looks set to be at the forefront during 2021 with the EU, UK, China and the new administration in the US all setting ambitious carbon reduction targets.  Encouragement from governments should provide incentives for investment into green infrastructure projects and as interest in sustainable investment continues to rise, a focus on businesses with positive social and environment impacts can be expected.

Companies and governments have been forced to borrow unprecedented sums to cover revenue shortfalls and protect workers and businesses during the COVID-19 period of restrained activity.  The intervention of central banks with quantitative easing has prevented upward pressure on global interest rates and this support seems unlikely to be withdrawn any time soon.

Interest rates are expected to stay at very low levels for a considerable period to allow economic growth gain momentum and impact on the level of debt, but the risk will be if inflation returns at a higher rate than expected or seen in previous periods of expansion.  Austerity and/or tax rate increases are methods of dealing with an increased debt burden but not politically or economically appealing. A period of above average growth with central banks allowing inflation to rise is certainly possible and investors should plan for this in their portfolios.

Income investors had a challenging time in 2020 with low bond yields and dividend cuts and suspensions, income levels for 2021 are still expected to remain below previous expectations.  More positively, the successful deployment of vaccines and an easing of restrictions should see many companies start to reinstate or revert to dividend growth from the as earnings recover, although for some companies the repayment of government support may limit their ability to pay out funds to shareholders ahead of the tax payer.

Summary

Constructing a balanced portfolio will continue to be challenging in 2021, as government and high quality corporate bonds will hold little appeal with interest rates at such low levels. For diversification and income, investors will be forced to look elsewhere with assets such as infrastructure likely to feature.

Equity market returns are unlikely to be as disparate across sectors as attention turns to whether the spectacular growth in areas benefiting from the pandemic can justify their very high valuations. This may present an opportunity for out of favour sectors at discounted valuations to recover. Diversification across regions, styles of investment and business sectors, rather than becoming too concentrated in particular areas seems likely to be a more appropriate approach to investing.

Provided that the vaccination programme proceeds as expected and there are no significant setbacks, such as a mutation of the virus which renders inoculations less effective, a relatively robust recovery in the second half of 2021 seems a reasonable expectation. Risks remain however given the scale of the crisis and the policy reaction provided, in particular an unexpected rise in inflation curtailing the scope for further monetary and fiscal stimulus. Nevertheless barring unforeseen events the scenario for markets appears to be reasonably positive as we start the year.

 

January 2021