2021 The Year of Recovery
The past year has been one for the history books. The COVID-19 pandemic triggered an unprecedented sudden shutdown of global economies with constraints on social activities and travel not seen in decades. There were massive protests and social unrest in the United States and across Europe. Further, in November we witness what was perhaps the most contentious and polarized US presidential election in recent history. The United Kingdom formally exit the European Union (EU) with a trade agreement. An arguably difficult year for most people, and a highly challenging one for many investors.
In 2021, we have reasons for cautious optimism. There is a good chance of getting economies and our lives back to normal. After a long year of difficulties, it looks like in 2021 we might be able to go back to the future.
The first year of the new decade, 2020 proved to be the most volatile since World War II. Financials, health care, technology, energy, and consumer durable sectors all lost value quickly as the pandemic spread throughout the US market and wider global regions.
However, as the year closed the S&P ended up 16.26% with technology stocks leading the way. The average dividend yield recorded was around 2.14% for the US blue-chip stocks, a less than average dividend payout rate. Interest rates have sunk to record low levels with the Fed Funds rate at zero percent and global Central Banks providing an unprecedented amount of quantitative easing created significant quantities of liquidity. The most recent forecast released at the Federal Open Market Committee (FOMC) meeting on Dec. 16, 2020, U.S. GDP growth is expected to contract by 2.4% in 2020. It is estimated to then rebound to a positive 4.2% growth rate in 2021, 3.2% in 2022, and a further 2.4% in 2023. These rates argue well for a US market recovery and above-average performance for US equities in the medium term.
The core inflation rate is predicted to come in at 1.4% in 2020, and slowly rise to 1.8% in 2021, 1.9% in 2022, and a further 2% in 2023. The Fed's target inflation rate is 2% set by the Federal Reserve Board. The core inflation rate, the Fed's preferred rate when setting monetary policy, strips out volatile gas and food prices.
The U.S. Energy Information Administration (EIA) provides an outlook on oil and gas prices from 2020 to 2050. It predicted crude oil prices will average $43 per barrel in the fourth quarter of 2020 and $49 per barrel in 2021 for Brent global. U.S. oil prices will also rise in 2021.
We have a moderately positive view of US equity markets in 2021. Volatility has come down since the U.S. Presidential election to a level where we do not expect to see significant spikes in the Volatility Index (VIX) that were experienced early in the pandemic. Investor sentiment and earnings forecasts for the first half of 2021 have become buoyant, which will likely lead to consolidation and perhaps a marginal correction early in the first quarter of 2021. Longer-term, we believe markets should trend higher as the economy normalizes with the distribution of the vaccine and adjustment to a new US Presidential administration. A resilient economic bottom appears to have formed, providing further support for equities.
Cyclical and value-oriented sectors most severely impacted by the pandemic shutdowns look the most attractive. We expect the greatest increases in earnings growth will occur in these areas, as they benefit from easier year-over-year comparisons and improving sentiment.
Dividend-paying stocks are a good example of a depressed segment poised for recovery. Dividend payers did not display their usual defensive characteristics during the height of the pandemic but instead recorded their worst performance in the last 20 years. In an environment where we expect interest rates to remain close to zero, dividend stocks offer more attractive yields relative to fixed income and the potential for growing payouts.
Simply looking at valuations would suggest technology stocks are overbought and most at risk of disheartening investors in 2021. On the other hand at current interest rates, technology valuations are well supported. Technology companies, which also include names in the communication services and consumer discretionary sectors, were beneficiaries of the work from home and e-commerce paradigm shift.
Given valuations have expanded, growth has increased as well and the major trends reliant on technology software and services remain in place. The pandemic accelerated those trends, making the digital parts of the economy larger, and we expect technology stocks will continue to grow faster than the overall market. In addition to taking on a more cyclical bias in 2021, we believe it is important to continue maintaining exposure to these technology disruptors that are transforming the economy. Smaller companies should also benefit from abundant liquidity, greater savings, and the gradual normalization of the economy as vaccines become available.
Despite the extraordinary events that characterized 2020, remarkably, the euro high-yield corporate market closed the year not far from where we were at the beginning of 2020. FY 2020 absolute returns ended in positive territory, slightly below the beginning of the year’s average coupon. Obviously, none of us expected to reach such yearly performance through the market swings of the COVID-19 pandemic. With most major economies at a standstill by the end of March. In April and May, credit rating agencies were busy downgrading both euro investment-grade and high-yield issuers as they sketch a grim forecast for 2020.
The COVID-19 pandemic was not going to hit economic activity evenly. Most manufacturing companies, after adjusting their production processes to align with the new health protocols dictated by the pandemic, quickly rebounded as consumer spending remained healthy. The quick recovery of the Chinese economy also meant that fears of major supply-chain disruptions were overdone. The strong market growth was met with tepid demand from pure European High Yield products that dedicated funds did not see commensurate inflows as other markets, such as US high yield.
We entered 2021 with optimism but are wary that the rollout of the various vaccines approved or likely to be approved will be a long process. As infection rates remain high across most major countries, the forecast is another quarter of constrained economic growth, and for a turn for the better during the second half of 2021.
The ECB and most major central banks are expected to remain accommodative, and euro sovereign yields likely to persist at historically low levels, we expect demand for higher-yielding products, particularly in the euro area, to remain high.
Banking sectors around the emerging world have seen earnings slide, asset quality deteriorates, and capital ratios fall; however, all of these would have been substantially worse were it not for the forbearance and policy stimulus that has been introduced to counter the effects of the pandemic. Banks are part of the solution in this crisis, rather than part of the problem, and so they will generally be aided and prevented from failing for fear of accumulating financial stability risks onto already precarious economies with limited policy ammunition left.
While financial markets have experienced a mean reversion from COVID-19, we fully expect asset quality indicators to continue to deteriorate, reflecting the gradual reduction of support measures. We think it unlikely that this will cause a delayed shock to global markets, but it probably will put continued pressure on earnings in the Emerging Markets for many quarters to come. In addition to the increased provisions for bad debt, banks will also suffer from interest rate margins pressure and very mixed lending demand – critical for balance sheet asset growth.
China has come through the pandemic better than any other large Emerging Market country and its external debt-issuing companies, responding in part to a combination of patient support and government stimulus. In the Middle East and Africa, there have also been a few defaults linked to poor governance. Asset recovery rates have been in line with analysts’ expectations, and above those seen in the United States.
Caricom regional countries are slow to report economic performance, however, made rapid adjustments to monetary policy as the pandemic spread swiftly across the region. Banks in Jamaica have postponed dividend payments, in Trinidad and Tobago monetary easing in 2020 resulted in significant market liquidity with the banking system recording the highest excess liquidity in the last few decades.
The Government of Suriname deferred the interest payments on their 2022 and 2026 Global Bonds after obtaining investors’ consents. They are currently negotiating an IMF package to cushion the negative Gross Domestic Product (GDP) brought on by the shutdown and lower than expected fiscal revenue.
The continued weak economic performance due to the Covid-19 effects will affect Caricom economies in the first half of 2021, however, we should expect a recovery in the latter half of the year. Economies that are more exposed to high Government debt ratios will be challenged to provide necessary fiscal stimulus and their recovery will be slower as we progress through the year.
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