Principal Monthly Viewpoints (December 2020)
Q: Principal Asset Management (Asia) Investment Management Team
A: Crystal Chan, Principal Asset Management (Asia) Senior Investment Specialist
Q: Will the global economy continue its strong recovery in 2021?
A: Global confirmed cases of COVID-19 continued to surge. Under the influence of the new wave of the pandemic, economic activities in major regions have once again been constrained, whilst the global economic recovery was held back in the fourth quarter. Looking into 2021, global economic activity is anticipated to recover significantly, with a forecast of 5% overall global economic growth, reversing the 4% contraction in 2020. The most significant driver for growth is the prospect of various vaccines could be widely adapted in the first half of 2021.
In the past few weeks, encouraging news on the development of the COVID-19 vaccine have been reported. The overall efficacy of the vaccines is higher than anticipated, which has shortened the duration of the global pandemic that market anticipated. With the first vaccine approved by the U.S. Food and Drug Administration (FDA), it is expected that high-risk groups in the U.S. could start to be vaccinated before the end of 2020 at the earliest, whilst the majority of Americans may be vaccinated by June next year. If the development of vaccines can keep up with the anticipated progress, the economy is expected to fully restart in the second half of the year.
Second, is the extension of global monetary easing and loose fiscal policies. To tackle the pandemic, countries and regions around the world have launched a total amount of fiscal measures scaled as high as USD 12 trillion. Central banks in various regions have also lowered their interest rates to near zero, whilst real interest rates have fallen to negative levels, which has significantly expanded their balance sheets.
Looking forward to next year, since the economy is expected to improve, the scale of fiscal measures may be weaker than in 2020. However, monetary policies will remain loose in the foreseeable future even if inflation has a chance to rise slowly. The balance sheets of three major industrial countries (the United States, Europe and Japan), as percentage of the GDP may climb from 38% in 2019 to 59% in 2020 and 65% in 2021.
Q: What is the outlook for global equities? How should assets be allocated in the first quarter?
A: The success of R&D and the application of COVID-19 vaccines are also the biggest driving forces for the global stock market to extend its upward trend of the past few months, at least in the first half of 2021. We believe that the positive news on the vaccines has not been fully digested by the market, especially in some of the cyclical and value-oriented sectors that are highly correlated with the economy. The current prices of those sectors are still a certain distance from the level before the pandemic at the beginning of the year.
Going into 2021, the continued recovery of the global economy will favor the performance of global stock markets. Using the MSCI World Index as a benchmark, integrating market forecasts, earnings of global equities may rebound from negative 17% in 2020 to positive 24% in 2021. Among which, earnings in the energy, industrial, consumer discretionary, and materials sectors are expected to lead the market.
Of course, from the perspective of valuations, equities are very expensive when measured by the price-earnings ratio, especially after the surge in November. However, from an asset allocation perspective, stocks still have relative investment values compared to bonds. In this ultra-low interest rate environment, more investors may be willing to take higher risks to obtain better returns. In terms of capital flows, as much as USD 110 billion inflow into the stock market was recorded in November, reversing the trend of annual net outflows.
Hence, if the economic recovery is stronger than expected while short-term political risks are subdued, funds may further flow out of the money market into risky assets. The high valuations of global stock markets can sustain, particularly in value-oriented, cyclical and small-cap stocks that have underperformed relatively in recent years. These sectors are worth looking into in 2021.
We remain bullish on the stock market for the first quarter. Among them, the Asian market has been revised upward to bullish, while the US and Japanese markets are slightly bullish. China and Hong Kong are neutral, and Europe is slightly bearish. We prefer cyclical-oriented sectors, such as financial, industrial, and energy stocks, as well as the technology sector which is still benefiting from the prospects of mid to long-term earnings growth.
Of course, on the other hand, the biggest potential risk factors that could threaten the market are the level of vaccine applications, whether the global epidemic can be truly controlled, and the prolonged negative impact of a series of blockades and quarantine measures on the economy. Moreover, the market has to pay attention to the weakened stimulus effect from monetary and fiscal measures owing to the anticipation of an improving economy.
Q: What is the outlook for global fixed incomes? How should assets be allocated in the first quarter?
A: For bonds, since the global outbreak of the COVID-19 pandemic, major central banks have actively introduced monetary-easing measures to respond to downward pressures on the economy brought about by the pandemic. In 2020, global central banks have reduced interest rates for about 75 times to provide sufficient liquidity to the market. The ultra-low interest policy has caused real interest rates in major countries to go into negative territory. Government bond yields are also at historically low levels.
As economies continue to recover gradually, particularly driven by positive news of the vaccines, the yields of long-term bonds may rise to reflect the expectations of economic growth. However, the possibility of major central banks raising interest rates in 2021 remains low. Take the United States as an example, unless inflation remains at an average of 2% for a prolonged period, the Federal Reserve will remain its monetary-easing policy. In fact, over the past 50 years, the conditions for meeting low unemployment rate and a continued 2%+ inflation rate have only occurred twice.
The extremely low-interest-rate policies in the United States and other developed markets are expected to last for at least two years. The rise in short-term bond yields may be relatively limited, whilst the yield curve is expected to become steeper. As a result, investors may wish to reduce the proportion of sovereign debt in their investment portfolios and shorten bond durations.
As for corporate bonds, the negative real interest rate of sovereign bonds is encouraging investors to purchase riskier assets to achieve higher potential returns. According to the information provided by the St. Louis Federal Reserve, as of early December, the annual inflation rate for the next 10 years is expected to be 1.89%, which is higher than the average yield of Bloomberg Barclays investment-grade corporate bonds of 1.85%, the first time since 2003, reflecting the strong demand for corporate bonds.
As the economy continues to recover in 2021, the credit spreads of corporate bonds are expected to narrow further. In terms of fundamentals, the launch of COVID-19 vaccines should support the global economy and corporate earnings are expected to rebound. This may improve investor confidence in the repayment of corporate debt. Corporate default rates may reach its peak in a short period of time. Investment-grade and high-yield bonds are worth looking into in the first quarter of 2021.
(Written on 10th Dec 2020)
Senior Investment Specialist
Principal Asset Management (Asia)