Insights & Perspectives
“Old and New Year – Be Bold”
As we head into the first full week of the New Year, we again use this time to review the main points that will be discussed in our “Old and New Year – Be Bold” webinar on January 19th, 2021.
While building our word clouds for 2020, we noticed that new words showed up as the world continues to try to cope with a global pandemic that is impacting every human being on the planet. Corona virus, family, vaccine… are only a few of those words. In the end, 2020 will probably be remembered as the year that we learned to value more what we already have and less what we want to have!!!!
There is no question in our minds about the short-term strength of the global equity markets. Fueled by unprecedented monetary and robust fiscal stimulus, the inevitable consequence of it (based on math), was asset price inflation. The question on everyone’s mind is how long can it last? The truth is nobody really knows. Nobody!!! Not us, not the largest and most sophisticated institution, not even Central Banks or Governments. What we know however, is that economic data, albeit improving, is still a long way from justifying the recent equity market performance and valuation. Said that, no one can afford to be on the sidelines. Instead, one must continue to participate in the markets, but focus harder than ever on time horizon, financial goals, and risk/return objectives.
What happened in 2020
To save you from reading again about the January/February 2020 “Old” All Time Highs; the Corona Virus pandemic + global lockdown; the market crash, depression-level economic data, unprecedented stimulus, and record equity market recovery; the Black Lives and All Lives matter protests; the US presidential election saga; the new “All Time Highs” led by technology and stay at home stocks; and the debate “For vs. Against” the vaccine, we will use one word to sum up the first year of the new decade: #UNTHINKABLE.
What to expect of 2021
We think is better to be “cautiously optimistic” than “overly aggressive” and we rather be “pleasantly surprised” than “miserably unhappy”. As such, although we are bullish over the immediate to short term, we must warn you that we are not wedded to that view. One thing that was reaffirmed to us over the last year is that anything can happen, and things can turn on a dime.
The sovereign debt overhang is just too much to swallow, the lack of monetary policy tools is just too obvious to ignore, the disagreement over fiscal policy will be hard to overcome, the problems permeating the fabric of our societies are very real and no longer happening on the margins; and yet, global equity markets will most likely continue to show exuberance.
Not surprisingly, words such as, revival, recovery, rotation, and renaissance have been dominating the 2021 outlook from major banks and investment firms. The consensus is that after the “flash-depression” moments of 2020, ongoing fiscal and monetary support and a vaccine have set the stage for a new period of economic growth and [further] rising asset prices. We agree, but not without major shake ups and regime shifts. The pandemic clearly brought to the forefront major issues regarding sustainability and inequality, as well as geopolitical issues and macro policies excesses that must be dealt with.
As nominal yields drift higher, we are inclined to shift exposures away from interest rate sensitive assets classes and sectors. Said that, central banks are committed to keep nominal yields on a tight leash despite resurgent inflationary pressures from structural changes triggered by the global pandemic. As such, it is unlikely that we will see a full rotation to traditionally value sectors from growth sectors, as historical data from periods of rising inflation suggests.
With inflation undershooting central banks targets during the recent past, market participants may be underestimating the potential for higher inflation. Commodity prices have been on an upswing since April 2020 and inflation linked bonds have been outperforming nominal bonds during the same time frame. Typically, this would suggest higher rates ahead and a bearish bias for capital markets and the economy, but with Central Banks keeping nominal rates low, the overall implications of the current dynamics are subdued real yields and strong economic growth ahead.
On top of the Radar
Buy the Rumors, Sell the News
Will the old adage hold true again?
Stocks need time to catch up to valuations. One of the unintended (maybe not so unintended as academia suggests) is asset price inflation. The math behind discounting future cash flow cannot be changed: in other words, dividing a number (assume a positive perpetual and constant cash flow) by another ever smaller number (here decreasing interest rates), will inevitably result in an ever-larger numbers (try to divide 100 by 2, by 1, by 0.9 and so on to see what happens!).
Markets can correct through price and/or time. Assuming we have wiling buyers at lower prices, time is then our best friend here. Upcoming earning seasons will give us the clue need to see if the “recovery-rally” has legs. In addition to valuation, capital market participants will have to start “separating the wheat from the chaff”. Zombie companies, those who cannot service their debt from generate profits, is said to account for close to 40% of the S&P500 roster. Prudent investors would think that is a problem!
Under the Radar
To cushion the pandemic’s blow and to help lift the risk appetite from March lows, the Federal Reserve has cut rates and initiated other easing measures, which led to the compression of interest rate differential between the U.S. and most developed economies. Furthermore, the U.S. congress continues to debate further fiscal stimulus to help households and businesses bridge the virus shock. As such, we continued to believe that USD weakness will be around in 2021, as the drivers for its recent decline remain in place.
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