THE year 2020 will be remembered in history as a year everyone would rather forget. It will also be a year that will be remembered for one word but then again, there are multiple words to describe the year itself.
Merriam-Webster and Dictionary.com named “pandemic” as their word of the year to describe 2020, while Collins Dictionary named “lockdown” as the word of the year. Oxford English Dictionary expanded its word of the year to encompass several “Words of an Unprecedented Year”. Words chosen include bushfires, Covid-19, WFH, lockdown, circuit-breaker, support bubbles, keyworkers, furlough, black lives matter and moonshot.
Clearly, the year 2020 was unprecedented and it will go down in history as one of the most challenging year for all, be it for the government, markets, central banks, investors, consumers, employees and most importantly, our frontliners battling Covid-19.
To recap, the year 2020 started out on a very firm footing and with full market enthusiasm. Some called it “melt-up” – the reverse of meltdown, as easy Fed’s money flowed into the system, driving asset prices and optimism. This “feel good” factor was obviously interrupted soon after World Health Organisation (WHO) declared Covid-19 as a pandemic on March 11. Thereafter, all hell broke loose for markets as volatility dictated market direction on concerns of impact from Covid-19 on the global economy and corporate earnings.
What followed was perhaps out of the ordinary if one were to judge based on the Dow’s performance alone. In the month of March 2020, the Dow went from a bear market to a bull market in a matter of days. Having dropped more than 11,000 points between the peak in early February to the low on March 23, the Dow rallied to be back on the bull market phase in just three days. In fact, the month of March was so volatile that the Dow had seven out of top 10 largest daily point gains ever and five out of the top 10 largest point losses ever.
While markets continued to gain ground as central banks stepped in to cut rates down to the floor and to provide stimulus packages by the trillions of dollars, the same cannot be said for economies globally. From lockdowns to job losses, global economy went into a tailspin as the second quarter was probably the worst quarterly economic meltdown ever. There was a clear disconnect between the market and the economy.
As Covid-19 numbers continued to rise globally, both in number of cases and deaths, we saw the gradual reopening of the economies as governments tried to balance between lives and livelihoods. As we just ended the year, all asset classes, driven by the flush of liquidity created, are either at the year’s best level or fresh all-time highs. This brings to question as to what the year 2021 will bring to investors?
Markets at its peak optimism level
The economy and markets are ushering the new year in a position of strength, again, driven by the view that the abundance of money supply created by global central banks will continue into 2021, driving asset prices higher and higher. Economic growth is set to sizzle this year on the much anticipated “V” shaped economic recovery while the other “V” – vaccine – will be the real kicker for consumption growth as more and more people get that two shots in the arm to protect themselves from Covid-19. With growth back on the horizon, naturally earnings estimates too are reflecting this blue sky scenario. So, what are the factors that will impact markets and economy in 2021?
There are indeed many factors but this column will focus on five main external factors that can dictate the market’s direction this year.
US and the rest of the world will see better years ahead
Let’s face it, most of us could not wait to see the end of the 45th US President’s term and it was rather refreshing to see most Americans felt the same way too when Joe Biden won the US elections and will take office in less than three weeks. With that comes the hope and believe as to what the Democrat President will bring sweeping changes to US’ relationship with the rest of the world, in particular with China.
The Phase One trade deal between the two superpowers is still in force for now but perhaps with greater awareness of a win-win situation. There is some glimmer of hope that the trade tariffs imposed will be unwind, but perhaps not in the immediate term. The US, under the new president, is also expected to be back joining the fight for climate change issues by rectifying the Paris Climate Accord, which was entered into by 196 nations just over five years ago.
The president-elect has already made known his plans for his cabinet and one of the most important position is the position of the US Treasury Secretary, a post to be assumed by none other than Janet Yellen, the former Fed chairperson. This is an important position as the Fed’s action will continue to dictate market’s direction this year. Having injected some US$3.23 trillion in 2020 and with the US dollar down by more than 7% last year, Yellen has already hinted that she prefers a stronger US dollar.
With that, comes a host of issues with respect to markets in an environment where interest rates are at the floor, globally. A strong US dollar will make US exports less competitive and US corporates too will see lower earnings growth in dollar terms. Nevertheless, despite a stronger dollar, US markets can still keep the momentum going on the back of flight to safety, expectations of currency gains and liquidity factors.
With the stronger US dollar, it also suggests than major currencies will weaken against the greenback and that, of course, includes the ringgit. This would benefit exporters but consumers would have to pay more for imported products. With that, key beneficiaries will be our export-based companies and, of course, this include our plantations, chip makers, glove producers and other manufactured products.
Vaccine – be prepared for element of surprise
The race to produce the first vaccine for Covid-19 started soon after the WHO declared that we are up against a pandemic. After Sputnik V was declared the first vaccine by the Russians, many others have come to market and globally, we are already seeing the initial mass distribution of the vaccine. While the vaccine has shown high efficacy level during clinical trials, the real test is when it is mass produced and distributed globally. This is where the time factor will kick in, as we will soon know to what extent these vaccines are as effective as claimed by the manufacturers.
As it is, even with the vaccine, the spread of Covid-19 remains unabated while at the same time a new strain is emerging and will continue to mutate. This brings a new challenge to the global economy as no one is certain how the virus or the vaccine will play out. As it is, markets are pricing a blue sky scenario with the expectations that the Covid-19 will no longer be a challenge for economies but whether that is the case or not remains a sixty four thousand dollar question.
The third, fourth or fifth wave may haunt markets in 2021 and this element of surprise can and will derail economic optimism, especially if it results in another round of lockdowns and long period of closures. With that, market’s overly bullish projections will be blown over and markets too will adjust to the new reality. In essence, we would have to come to our senses that Covid-19 is here to stay.
Technology will remain key driver of behavioural change
Work from home, online shopping and digital platforms is the new normal for everyone. Covid-19 has brought about behavioural changes and some of these changes are going to be permanent. Businesses and consumers will have to adopt to this new environment by embracing technology to get things done. We will see instead of startups disrupting the traditional way of getting things done, it is the incumbents’ turn to disrupt the disruptors to remain relevant. Competition will go up a few notches to either sustain or gain market share and the losers will be those who refused to change.
We will see more businesses going under in 2021 while merger and acquisition or privatisation too is expected to remain active as number of players in all sort of industries will likely shrink due to the competitive environment and change in consumer patterns. How will this impact stock selection for investors? Simple, the technology sector is expected to remain buoyant, driven by change in behaviour as demand for devices, services and speed will remain elevated.
With that, our electronics manufacturing services (EMS) and semiconductor chip makers will be the key beneficiaries of this pent-up demand. E-commerce too will be huge as more and more players come into the crowded space to gain market share. One does not look for in terms of how much investors love e-commerce stocks by just looking at the performance of companies like SEA Ltd, the owner of Shopee, whose share price was a five bagger in 2020.
Low global rates
As it is, global interest rates are at the floor while market rates are being pushed lower and lower to even below sub-zero. The traditional finance and the role of money in the economy has taken an unimaginable turn as investors, who are flushed with liquidity, driven by unprecedented money creation by global central banks, has caused sovereign and investment grade papers to hit historical lows.
Today, some US$18 trillion worth of global debt papers are trading at below zero while only 15% of all global bonds have a market yield of above 2% and only 10% are above 3%. In search of yield and returns, investors are going on longer duration papers and lower credit qualities to generate a decent return on their portfolio. However, this is a dangerous game as markets are expected to turn when economic recovery is well entrenched and when the threat of Covid-19 is reduced to mankind.
Inflation expectations too will rise as it is likely that general prices will rise once consumer confidence is back again while job market reaches near-full employment. Once interest rates start to rise, the steepening of the yield curve will see investors rushing out of fixed income, while those who remain invested will be up against mark-to-market losses.
On the other hand, as investors are also positioning themselves on lower credit rated papers as well as high yield papers, should Covid-19 persist and vaccines prove to be ineffective, default rates are expected to rise. Hence, looking at the overall picture for fixed income, the asset class appears frothy and investors should in actual fact reduce their market exposure.
The year 2020 was indeed a washed out year for consumers and with the year 2021 starting out on an optimistic note, it is likely we are going to see a rise in consumer spending globally. This is also aided by cash handouts from the government while recovery in economic momentum, new job creations, as well as steady and stable income would indeed bring back demand, especially for consumer discretionary goods.
The caveat here is again Covid-19 and that the vaccine will be effective to not only contain the spread of the virus but allowing economies globally to return to pre-Covid-19 phase. Should this materialise, the recovery theme that we observed soon after the various vaccines were declared to have very high efficacy rates by their respective manufacturers will play out in the market. This is where cyclical or bombed out stocks will enjoy a re-run with banking stocks leading the way, followed by consumer names, property stocks and of course, construction names too.
There are two more critical themes that will likely become more forceful this year and they are investing in companies that are environmental, social and governance (ESG)-compliant and those that are taking steps to adopt climate change in their business processes and activities.
ESG theme is gaining momentum worldwide and has clear records that show how these standards are practiced and delivered to stakeholders. Globally, based on data compiled by Bloomberg, the ESG universe saw asset under management more than doubled in 2020. Another theme that is increasingly being assessed within the ESG space is climate change. How corporates adopt climate change in their businesses will be closely scrutinised by fund managers.
In conclusion, as we welcome the New Year and wish that it will bring us prosperity, happiness and good health, we must remain vigilant on the challenges that we will face.
As markets are near or at all-time highs, thanks largely to the US$22 trillion debts that have been created worldwide last year alone, much of the future asset-price increase will likely depend on the positive outcome of the five factors mentioned above or the continuous increase in the size of central banks’ balance sheet as well as the enthusiastic investors who sometimes just disregard valuation point but simply ride on the momentum, especially in the post-pandemic world.
Pankaj C. Kumar is a long-time investment analyst. Views expressed here are his own.
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