We cannot yet be sure how this pandemic will end, but with the mass deployment of vaccines now under way, today’s high infection rates could be materially lower in a few months’ time.
Financial markets were quick to respond last year, scenting better times ahead despite the daunting economic challenges we still face today. After what was one of the shortest bear markets in history, asset prices climbed and volatility fell on an almost linear trajectory, right through to year end. Global equities posted a 14% return in 2020, despite what was, in Britain’s case, the deepest recession in 300 years.
It was not only equities that prospered last year; government bonds, credit, hedge funds, commodities, residential real estate and infrastructure all showed positive gains, alongside windfalls for investors in gold, silver and the digital or crypto currencies. This near ‘universal’ asset appreciation is not hard to explain. In the face of economic lockdown, policy makers drew on their playbook from the 2008 Financial Crisis but this time with greater urgency and scale. They executed massive central bank bond purchases, direct market intervention and simultaneous fiscal programmes. While this succeeded in blunting the economic impact, it was also rocket fuel for financial markets. Bond yields collapsed, interest rates fell to zero or below (and central bankers committed to holding them there) while personal savings rates soared (triggering a wave of retail stock buying). The result was a higher equity risk premium as earnings yields on stocks looked attractive relative to bonds or cash – this led to a wholesale re-rating of risk assets.
The Green Shoots Of A Post-Covid Recovery?
So where to from here? Reflecting on 2020, our focus is understandably on the human tragedy of the pandemic but that perhaps makes it easy to miss some surprising progress in other fields. Developments particularly in the political, environmental and regulatory space, most of them positive, will help shape our portfolios in the year ahead:
Perhaps historians will come to see 2020 as a moment of political rebirth. This was, after all, the year that America’s political system corrected itself, ending its brush with the quasi-authoritarian populism of the right, but also rejecting a destabilising populism of the left (despite the recent Georgia Senate wins for the Democrats). In Europe it was also the year that Ursula von der Leyen and Angela Merkel under Germany’s presidency of the EU council successfully brokered the 750 billion euro EU recovery fund, offering a ground-breaking mix of loans and grants, borrowed collectively. Arguably, this tentative first step along the road to mutualising part of Europe’s debt, could never have taken place without the urgency brought on by the pandemic. Finally, of course there was Boris Johnson’s Brexit deal – which, despite its modest ambitions, is still a remarkable achievement in the timescale and conditions under which it was negotiated. Yes, the deal is limited in scope but it offers a robust platform to build and deepen relations over time.
2. The environment
It is only the very beginning of a long journey, but new commitments to carbon neutrality by corporations and governments (including China, the UK, France and Japan) have been one of the most extraordinary achievements of 2020. COVID-19 appears to have accelerated efforts to shift to a savvier form of globalisation that prioritises climate, as a means to build post-pandemic resilience. The Chair of the EU Parliament’s Environment Committee called it “the biggest green investment shock ever made.” We at Sarasin have been active for some years on your behalf, voting and nudging our companies to embrace clear Paris goals – we will now spend many more years monitoring their execution.
European authorities, who have long had big American tech companies in their sights, are likely to heighten their scrutiny in 2021. In the US, a new bipartisan consensus is emerging in favour of tougher antitrust enforcement of the PARTNERlargest players, whilst even China, the self-proclaimed architect of home-grown national monopolies, appears to be having second thoughts. Beijing is talking of a ‘rectification drive’ to bring Jack Ma’s Ant Group more closely under its control, whilst also initiating monopoly investigations into Alibaba and other tech giants. We are a long way from a global consensus about how to regulate or tax big tech, but perhaps 2021 will mark the first serious attempt to set some boundaries – this is to be applauded.
Counterintuitively, 2020 has witnessed a surge in new business start-ups, initially in the US but also now in the UK, Germany, France and Japan. In the US, new business applications rose 70% in the three months to September, France registered 84,000 in October, up 20% from a year ago, while in the UK, online retailing was the driver of a surge in registrations last month. Mergers and acquisitions activity has also been robust with deal volumes globally only 6% below 2019 – an extraordinary achievement when you consider the freeze in activity in the first half of the year. In December for example we saw three of the largest global deals complete1; S&P’s purchase of IHS Markit, AstraZeneca’s purchase of Alexion Pharma and Salesforce’s purchase of Slack Technologies. We should expect a very active M&A market again in 2021 as both COVID winners and losers reposition their business models.
Our greatest worry as we look ahead to 2021 is rising inequality. The virus has tended to hurt the lower skilled (less able to work remotely), minorities and low-income economies (especially sub-Saharan Africa). Even in the US the Economist Magazine reports that 32%2 of households earning less than $25,000 have been forced to miss meals. By contrast today’s low interest rates and bond yields have lifted the value of stocks and other risk assets which are disproportionately owned by richer households. Governments need to respond with ambitious ‘levelling-up’ agendas and re-training policies alongside debt relief for poorer countries. Expect windfall and possibly wealth taxes to fund this. Against this backdrop we, as fund managers, will be monitoring how our companies support their workforces and their wider corporate supply chains as part of our governance process.
Our second key risk is the bond market – the orderly climb in US yields to 90 basis points (they bottomed at 50 basis points on 4 August) holds little risk as yet. But, in the face of a successful global vaccination plan, and a less constrained Biden spending programme it is possible that we see a surge in economic activity this summer. Yes, it may feel a world away, but imagine cash-rich consumers (US households received an additional USD one trillion3 in personal income support in 2020), government infrastructure programmes and green investment all deployed simultaneously. A roaring 2020s, with central banks reluctant to step in, could see bond yields climb, possibly sharply, and equity valuations that will have to reset in response.
The active deployment of vaccines alongside still generous central banks, continues to be positive for risk assets. So, despite the daunting infection data seen today, we have raised our stock exposure to overweight, expecting much of 2021’s returns to be front-loaded. Within this we have no strong style bias, seeing opportunities in both industrial holdings geared to climate and infrastructure spending but also in the digital winners that are not the main target of regulators. We also favour UK equities, noting attractive valuations and the likely return of foreign funds in the wake of the Brexit deal. Our caution comes in the bond markets where we have just reduced our credit exposure, after an extraordinary rally, and remain underweight government bonds. We may be early, but the brave new world we hope for in 2021 will at some stage need a new interest rate policy to go with it.
1 Source: Bloomberg
2 Source: The Economist Magazine January 2020
3 Source: US Bureau of Economic Analysis