Investment and Economic Outlook for 2021
- 04 December 2020
- 15 mins reading time
On 24 November we hosted a webinar in which the investment and economic outlook for 2021 was discussed. This briefing is based on that content.
A year dominated by Covid-19
It’s been a year of tragedy and tumult. The 60 million Covid-19 cases worldwide have led to the loss of nearly 1.5 million lives so far.
Lockdown measures have been necessary to stem the human cost, and that’s had a fundamental effect on the secondary considerations of economics and investments.
Economic growth reversed, stock prices slumped and the demand for and prices of perceived “haven” investments, such as gold and government bonds, rose sharply in 2020.
Governments and central banks have had to provide enormous financial support. Measures have ranged from furlough schemes and restaurant vouchers to super-low interest rates and huge injections of new money through quantitative easing.
Quantitative easing is the contemporary equivalent of printing new cash.
Most money is no longer physical cash. So when the Bank of England, or any other central bank, wants to increase the amount of money flowing through the financial system, rather than printing physical money, it simply increases the number on its electronic bank account. As the controller of pounds sterling, it can do this. No other bank or organisation can.
It then uses this new money to buy assets, such as bonds, from large financial institutions including commercial banks and pension funds.
The idea is that those financial institutions use that money to lend to clients or buy other assets.
That increases the supply of money in the financial system, helping to make lending cheaper and inflation higher.
Implications for companies
Most companies have had a difficult year with sales and profits declining. The worst hit include oil-producers, banks, and travel and leisure companies. These, in turn, have felt the falling demand for oil, squeezed profits on lending, and the inability of people to socialise or travel during lockdown restrictions. It’s not been equally bad for everyone though. The small group of extremely large online-based companies that dominate the US stock market, has fared well.
Apple, Amazon, Facebook, Netflix and Google have benefited from the increased need for their services.
The rise of these tech giants has enabled the US benchmark S&P 500 stock index to recover quickly and hit new record highs, even as the pandemic rumbles on.
The UK economy has not fared so well. As well as a controversial handling of the pandemic, domestic investments have been affected by worries over the global economy and, of course, Brexit.
Chart 1: Sharp rise in public debt
This chart shows how the total value of assets (such as bonds) owned by the Federal Reserve has increased as a result of quantitative easing. GDP = gross domestic product i.e. the annual economic turnover. Source: Schroders Investment Management/ Refinitiv/ US Federal Reserve Economic Data, November 2020.
Is a Brexit deal more likely?
The moderately good news is that the UK and the European Union (EU) finally appear to be moving towards a trade deal of sorts. We don’t expect this to match some of the more ambitious hopes expressed by a selection of UK politicians since 2016, but the shock of a no-deal scenario seems less likely.
However, we do anticipate some friction as the thorny subjects of fishing rights and equal market access are hammered out. Then there’s the process of ratification which requires individual approval from each of the remaining EU member countries.
Whatever situation we do find ourselves in, the French government has indicated that it will be open to a gradual imposition of new restrictions. That, alone, is very positive.
Chart 2: Bank of England economic projection
This chart uses data from the Office of National Statistics and the Bank of England’s own projections to present a positive view of the coming years. The darker the colour, the more likely the outcome. Source: Schroders Economics Group/ Bank of England Monetary Policy Report, November 2020.
Virus cases still rising in the US
In the meantime, it’s likely to be some months before we emerge from the pandemic. The various vaccines being developed have led to brief moments of euphoria as people long for a post-Covid-19 world. But it will take time to achieve final approval, mass production, distribution and administering of vaccines.
At the time of writing, European countries are under increased lockdown measures and case numbers in the US don’t appear to be falling. In short, things might get a little worse before they get better.
As a result, the long-awaited economic recovery could be W-shaped with the second, less severe wave of virus cases and lockdown measures taking their toll.
But, as the Bank of England’s numbers in chart 2 show, there are strong prospects of a robust rebound in economic activity over the coming year or two.
China and emerging markets look positive
China, the world’s second-largest economy, imposed some fairly draconian measures to contain the virus. These appear to have been successful, enabling the country to return to work in fairly short order.
At the same time, the demand for perceived “havens” has fallen. The US dollar is one such “haven”, and its falling value relative to other currencies is important to emerging market countries such as those across southeast Asia.
These countries have considerable borrowings denominated in dollars. So when the value of the dollar falls, so does the total value of their debt. That reduces the monthly payments they have to make, affording them greater opportunities for spending on investment and welfare.
This supports our expectation that carefully selected stocks and bonds across emerging markets can offer attractive opportunities in the coming months.
Will UK interest rates go negative?
Closer to home, interest rates are at all-time lows. Central banks, including the Bank of England, have made it clear that interest rates are likely to be kept low for the next year or two as borrowing costs are held down to support businesses and households.
However, while there is talk of UK interest rates turning negative, we don’t think that this is likely at the moment. Firstly, there is already considerable support being provided through quantitative easing and government support. Secondly, negative interest rates probably wouldn’t provide much additional stimulus in our view. Thirdly, negative interest rates would undermine the ability of banks to lend to customers in a profitable fashion.
And, finally, lowering interest rates to negative levels in the eurozone helps to keep the value of the euro low, making their export pricing attractive to overseas buyers. The pound, by contrast, is low already as the country faces the uncertainty of Brexit and the aftermath of UK Government measures to combat the pandemic that have had mixed results.
Coping with the huge debt levels
Lower interest rates will be helpful in the ensuing years as successive governments pay off the vast amounts of debt that have been racked up during the pandemic and lockdowns.
The key, as we see it, is that economic growth is needed to generate higher tax revenues that will enable this debt to be paid off over time. We believe that the unprecedented measures taken to support businesses and households were appropriate.
For these measures to make sense, though, we think that they need to be extended in the form of sustained low interest rates, further quantitative easing and resisting the temptation to raise taxes too soon.
The government is seeking some opportunities to reduce the long-term financial burden by targeting measures that are less likely to lose votes. Reduced payments to overseas aid, an increase in capital gains tax to align with income tax and lower pensions tax-free allowances are all considerations that have been floated through the media to see how much of a reaction they trigger.
We would not be surprised to see a combination of these measures implemented in 2021. But the stark reality is that what we need now is economic growth, and anything that undermines that would be financially problematic and, in all likelihood, politically unpalatable.
US political clarity
We anticipate that a pro-growth approach is likely to be supported by the latest developments from the US where Joe Biden has, finally, been confirmed as president-elect.
While he appears unlikely to win control of the Senate (this will be decided during the January run-offs in Georgia), his limited power might also be welcome by investors.
His likely inability to raise taxes or impose regulatory scrutiny on technology firms diminishes efforts that would have eaten into company profits.
However, with former head of the Federal Reserve, Janet Yellen, looking likely to become the next Treasury Secretary, we can expect a pro-growth approach. This will bolster two of his stated priorities: providing more financial stimulus, and tackling the virus.
Which assets classes could fare best?
The rapid development of Covid-19 vaccines has given stock prices a huge boost, especially those that suffered the most during the lockdown period. We expect their prospects to remain positive, assuming they can survive the next few months. The sectors that have been left behind and which might catch up include finance, utilities, energy, travel and leisure. Due to their low stock prices, these can all be considered “value” stocks.
That said, we still have a positive outlook for “growth” stocks, i.e. those that might be moderately expensive, but which have good prospects of growing market share, revenues and profits over a sustained period of time. The obvious examples are the technology giants referred to earlier in this briefing. For now though, their prices are coming down from extraordinary highs as investors consider the greater stock price rises that might be available in value stocks.
The outlook is less favourable for government bonds, especially in developed economies such as those of Europe and North America. Their prices are so high that we cannot see much scope for further rises next year.
By contrast, corporate bonds appear more attractive. We expect the companies behind them to be supported by economic growth and continued financial stimulus.
2020 will be remembered as the year of the virus. It has had a devastating effect on countless lives which, unlike the economy and investment scenario, can never be healed.
Any views expressed are our in-house views as at the time of publishing.
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Forecasts of future performance are not a reliable guide to actual results in the future; neither is past performance a reliable indicator of future results. The value of investments, and the income from them, may fall as well as rise and cannot be guaranteed and the investor might not get back their initial investment.
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