What comes after the tumult of 2020?
After this year’s dramatic moves in markets and the global economy, 2021 offers the prospect of a gradual return to normality. But with global shares close to record highs, there is a risk that investors will be disappointed.
2020 saw one of the steepest falls in US equity markets of the past century – but ended with the S&P 500 in comfortably positive territory. The stock market is not the economy. However, to a large extent, equity prices have been tracking the tumultuous economic path triggered by Covid-19. After a sharp fall in output in 2020, we now expect stronger-than-average growth for each of the next two years (see chart below). This should leave global output slightly ahead of its pre-pandemic level by the end of 2021 – though it will still be significantly below the level it would have likely reached in the absence of Covid-19.
Contributions to global growth (y/y change, %)
News of the discovery of a vaccine, far sooner than expected, has led to further optimism about the recovery. Vaccines will not be deployed quickly enough to prevent more economic disruption early in 2021, with widespread restrictions still in place across Europe. However, the prospect of an end to the pandemic should significantly boost confidence.
In equity markets, this has been reflected in the stronger recent performance of more cyclical sectors, which stand to benefit from the improved economic environment. This includes sectors such as banking, industrials and materials, as well as those more directly impacted by Covid restrictions such as leisure. We think this move could have further to run.
It is now very clear that the economic impact of the pandemic, and the recovery from it, has not been the same around the world. There has been significant dispersion in economic outcomes, which has also been reflected in regional equity market performance. Notably, China was the only major economy to avoid a contraction last year, with our economists expecting an increase in output in the region of 2%. This is astonishing, especially in comparison to the UK’s performance: we expect figures to reveal a contraction of some 10% for 2020. China’s strong performance is set to continue, with the country accounting for some 30% of global growth in 2021. This strengthens our conviction that China will play an increasingly important role for investors – and in our portfolios – in the coming years.
One-year performance of regional equity indices, rebased to 100
Source: Refinitiv Datastream, Cazenove Capital
Risks to the outlook
There are clear risks to our relatively optimistic forecast. The pandemic is the obvious one. The timing of a return to normality is still very unclear. Even in a best case, it will take many months to vaccinate enough people to have a significant impact on transmission rates. And there will be challenges on the way. Covid-19 is still spreading rapidly in many parts of the world, with a new strain of the virus in the UK causing particular alarm. This has the potential to derail the more recent optimism created by news of a vaccine.
Inflation is another risk. We do not expect to see surging inflation any time soon, with unemployment still high and output below the level suggested by the trends of recent years. However, if there is a strong recovery, signs of higher inflation could prompt market participants to question central banks’ ability to continue providing the same degree of support – and potentially the Fed’s commitment to its new average inflation targeting regime. Market panics in 2013 and, more recently, 2018 are useful reminders that concerns over premature tightening of monetary policy can be very destabilising.
As ever, politics remains a risk – but there is also a possibility that once some near-term uncertainties are out of the way we could return to a less tumultuous political environment.
At the time of writing in late December, Brexit negotiations continue with both the UK and EU warning of the rising risk of “no-deal”. Previous European crises suggest that agreements are often reached at the very last minute – after weeks of brinkmanship, played out in the press. This could well be the case again – but the possibility of “no deal” is non-negligible. Even if there is an agreement, we would expect it to be of relatively limited scope, requiring further negotiations on specific sectors. However, following an initial deal, these negotiations might generate less political drama – and less impact on the UK’s economic mood.
In the US, the uncertainty of the election is out of the way. Joe Biden should bring a more measured and multilateral tone to international relations – and there will certainly be less policy-making on Twitter.
Yet there are still risks arising from US politics. A runoff vote in Georgia early in January could move the balance of power in the Senate in favour of the Democrats. This would facilitate more fiscal spending – but it could also open the door to a sharp rise in US corporate taxes, reducing company profits by some 10%. As things stand, it now looks likely that a $900 billion stimulus package will be approved by Congress. This will include direct payments of $600 to individuals earning $75,000 or less. However, economists and investors are already questioning whether the package will be enough to help the US economy navigate a difficult few months. Assuming the Senate remains in Republican hands, negotiating additional stimulus spending could be difficult.
Looking further ahead, Biden’s presidency may bring less change in US policy towards China than hoped. This could lead to disappointment for investors counting on a resurgence of global trade and exports. Recent surveys show increased wariness of China amongst both Democrats and Republicans. The fact that China’s relative economic standing has significantly increased in the wake of the pandemic is unlikely to go unnoticed by those in Washington calling for tougher policies.