2021 Investment Outlook
Last year, investors were faced with many challenges, most notably, the spike in market volatility due to the pandemic-induced social distancing recession. To combat this, the Federal Reserve (Fed) provided extensive monetary support through interest rate cuts, new liquidity facilities, and large-scale asset purchases. Equally effective, fiscal relief in the form of the CARES Act provided much needed financial support to millions of Americans and businesses experiencing financial hardship. Together, monetary and fiscal policy helped deliver substantial aid to a very weak economy in the first half of 2020, sustaining the early stages of the recovery through the second half of the year.
The volatility and turbulence of 2020 left investors questioning what lies ahead for the economy, the markets, and key asset classes in 2021. To help answer these questions, we share a synopsis from some of the top investment managers, as well as our own thoughts, on the year ahead.
Most global economies enter 2021 in early-cycle recoveries, with a prospective economic reopening likely to lead to a broadening expansion as the year unfolds. The winter rise in virus cases represents a strong near-term headwind but is unlikely to cause a double-dip recession. Global monetary policy remains highly accommodative and supportive of asset prices, but the fiscal policy outlook is more uncertain
Amid positive vaccine news, investors’ expectations for a full economic reopening have underpinned a reflation trade that is driving Treasury yields and stock prices higher. With higher asset valuations already reflecting positive expectations for reopening, financial markets may be influenced heavily by the trajectory of policy, inflation, and real interest rates; therefore, some volatility is likely.
After sustaining an unprecedented shock from COVID-19 early in 2020, the global economy is ready to get back to normal in 2021…with the help of one or more vaccines. For the first time in a while, we see more upside than downside risks to our moderately constructive outlook for next year, but very near-term risks skew to the downside. Our key takeaway for 2021: A bright light lies ahead for investors, but only at the end of a very dark tunnel.
While the promise of a better 2021 is at least partially priced in, accommodative policy and a snap back to normal in distressed service industries can help investors earn solid returns in the coming year. Even so, we believe both equity and credit risk will add to portfolios’ performance in 2021. The expected earnings recovery — S&P 500 earnings estimated to be up at least 25% next year — will ease pressure on valuations and still allow for reasonable returns on stocks. Corporate credit spreads have narrowed impressively but could compress further given the very low level of underlying rates and the outlook for better growth by the second half of the year. Interest rates remain pinned at the short end of the curve by extremely vigilant central banks determined not to tighten policy too soon. Absent an unexpected burst of inflation next year, any rise in longer-term rates is likely to be gentle.
For 2021, our outlook for the global economy hinges critically on health outcomes. Specifically, our baseline forecast assumes that an effective combination of vaccine and therapeutic treatments should ultimately emerge to gradually allow an easing of government restrictions on social interaction and a lessening of consumers’ economic hesitancy. But the recovery’s path is likely to prove uneven and varied across industries and countries, even with an effective vaccine in sight. We expect growth of 5% in the U.S. and 5% in the euro area, with those economies still falling short of full employment levels in 2021. In emerging markets, we expect a more incomplete recovery, with growth of 6%.
Interest rates and government bond yields that were low before the pandemic are now even lower. Our expectations are for short-term policy rates targeted by the U.S. Federal Reserve, the European Central Bank, and other developed-market policymakers to remain at historically low (and, in some markets, negative) levels into 2022 before eventually beginning to normalize to pre-COVID levels. Yield curves may steepen slightly as long-term rates in our baseline forecast rise modestly. The outlook for the global equity risk premium is positive and modest, with total returns expected to be 3 to 5 percentage points higher than bond returns. This modest return outlook, however, belies opportunities for investors by investing broadly around the world and across the value spectrum.
Following a winter slowdown, widespread vaccination should allow U.S. growth to surge later in 2021, precipitating a relatively fast rebound from a deep recession. However, the recoveries for GDP, jobs and inflation are on different timetables with important policy implications. Earlier this year, as the pandemic led to a widespread shutdown in economic activity, it seemed that the most likely shape of the U.S. recession and recovery would be a plunge, a bounce, a crawl and a surge.
Earnings should rebound but overall U.S. equity returns may be constrained by high valuations. A cyclical rebound should produce at least a temporary rotation from growth to value. International equities should benefit from a falling dollar and lower valuations relative to the U.S., with the more cyclically geared regions outperforming. A commitment to maintain very low short-term rates until the economy reaches “maximum employment” could lead to a steepening of the yield curve in the year ahead.
T. Rowe Price
New coronavirus vaccines offer a potential lift for economies in 2021. However, a spike in COVID‑19 cases could slow recovery in the first quarter. The 2020 global pandemic tested the ability of companies and investors to manage their way through an unforeseen and dangerous period. However, T. Rowe Price investment leaders believe the other side of that journey could come into view in 2021 if new vaccines and continued fiscal and monetary stimulus add momentum to the economic recovery.
A broader economic recovery is likely be an uneven road to recovery and to benefit many of the sectors that were most damaged by the virus, such as travel, leisure, energy, and financials. However, technology, e‑commerce, and home delivery firms that saw sales surge during the pandemic could face tough earnings comparisons. A broader economic recovery also could produce a modest uptick in inflation, which decelerated in early 2020 as the pandemic spread. Forward‑looking measures of inflation expectations, such as spreads (differences) between nominal and inflation protected government bonds have rebounded sharply since mid‑2020.
For U.S. and global equity markets, a rapid economic recovery could bring an accelerated earnings recovery. However, rapid earnings growth might not translate into strong equity returns in 2021. Despite the sharp earnings decline seen during the pandemic, most global equity markets appeared set to finish 2020 with strong gains for the year with a lot of the recovery already priced into the markets. In style terms, a more normal cyclical recovery could continue to boost value relative to growth, a reversal of the powerful trend toward growth dominance—and unprecedented dispersion of stock returns—seen since the 2008–2009 global financial crisis. On the fixed income side, investors face a more challenging environment. With short‑term yields at ultralow or negative levels and the U.S. yield curve steepening as economic growth and inflation expectations revive, interest rate risk could become a critical issue.
Capital Group believes that the global economy is turning the corner toward recovery. The pandemic-induced shutdown of 2020 — which caused the worst recession since the Great Depression — is expected to be followed by solid growth in 2021 across major economies. The International Monetary Fund (IMF) estimates that global GDP will climb 5.2% in 2021.
The biggest risk to the recovery remains the resurgence of COVID-19. Low rates will continue to support asset prices, as investors look towards the higher return potential of equity. The Fed has committed to maintaining near zero interest rates well into the recovery and therefore Capital Group does not expect any rate hikes for the next two to three years.
Digital leaders across industries are leaping ahead of the competition, Covid ramped up the widespread adoption of digital. Companies with strong online business models are soaring above the competition. However, not all experiences can be digitized. Pent-up demand may fuel a comeback in travel and other hard-hit sectors.
An ultra-low interest rate environment encourages investors to move into riskier assets, such as stocks. Given secular trends, high-valuation growth stocks were market leaders both on the way down and on the way up — looking further out, Capital Group expects a broader recovery across more sectors.
For some areas of the economy — restaurants, hotels, retailers, airlines, and small businesses — it has literally been the worst of times. Companies with fast and efficient online business models are soaring above the terrestrial competition, disrupting the status quo, and displacing old-economy stalwarts. The growth rates at companies with a digital advantage have been phenomenal. When the pandemic is over, we may see slower growth rates, but a continuation of the secular trend. Investors should keep in mind, however, that the digital advantage only goes so far. While it is a powerful force in many industries, there are some places where it takes a back seat to good old-fashioned manufacturing muscle. America is likely to remain a primary engine for innovation, but it would be shortsighted to think of the U.S. as the sole province of inventive companies.
In fixed income, credit sectors still offer value versus Treasury bonds, but selectivity is crucial. The teams analyze credits and find value in certain bonds.
PIMCO expects the global economy to continue its transition to healing in 2021 and get closer to pre-crisis trends, especially in the second half of this year. The sectors most hit by COVID-19-related restrictions – travel, lodging, restaurants, leisure, etc. – should benefit the most. World GDP (gross domestic product) growth in 2021 is expected to be the highest in more than a decade and economic activity in the U.S. should reach pre-recession peak levels during the second half of this year. Global output and demand are likely to rebound strongly in 2021, driven by the rollout of vaccines and continued fiscal and monetary policy support. Inflation should creep up only moderately in 2021. Central banks’ policy rates are likely to remain low, and asset purchases will likely continue.
Consumer price inflation may increase moderately during this year and remain below central banks’ targets. In the U.S., low mortgage rates and downward pressure on rents in the next couple of quarters will weigh on the shelter component of the consumer price index (CPI), which accounts for slightly more than 40% of core CPI.
Fiscal policy remains the main swing factor in the cyclical outlook, as most governments keep propping up household incomes via transfers and supporting companies via loan guarantees, subsidies, and tax breaks.
PIMCO expects a range-bound environment for government bond yields over the coming few years. Central banks across the board have signaled that it will be a long time before tightening.
They are neutral overall on duration, as the expectation is that the yield curve will continue to steepen. While central banks will keep short rates low, over time markets will price greater reflation into the longer ends of curves. PIMCO sees little inflation upside risk over the near term but is concerned about inflation over the longer term, given the extent of monetary and fiscal policy accommodation. They believe that U.S. Treasury Inflation-Protected Securities (TIPS) offer a reasonably priced hedge against higher inflation over the secular horizon.
PIMCO anticipates having overweight spread positions in portfolios, coming from mortgages and other structured products, selected corporate credit, and hard-currency-denominated emerging market sovereign credit exposures.
As the number of virus cases surge, we expect a slowdown of economic activity in first half of the year. However, increasing vaccine distribution may reopen the economy in the second half of the year. An agreement on a stimulus package will also help consumers worried about rent payments and expiring unemployment benefits.
With both domestic and global GDP expected to rebound, high cash levels on the side-line, and low interest rates, equities will continue to perform relatively well. More confidence in global economic growth may lead to a rotation into value, as the sector is more cyclical in nature. Secular themes, like digitalization, favor the growth sector. Valuations as measured by Price/Earnings or Price-to-Book, are historically high and may mute equity performance. However, valuations relative to Fixed Income yields are more reasonable.
The Fed will continue to be supportive but will eventually taper bond purchases; thus, we could see the yield curve continue to steepen. Short-term rates will stay low but intermediate and long-term rates may rise. Traders see U.S. inflation averaging at least 2% per year over the coming decade – this is the first time expectations have climbed that high since 2018.
In the face of last year’s challenges and the ongoing uncertainty, we recommend investors maintain a diversified portfolio that aligns with their goals and risk tolerance, in order to help weather the storm.
Note: Views expressed are as of the date indicated, based on the information available at that time, and may change based on market and other conditions. Unless otherwise noted, the opinions provided are those of the authors and not necessarily those of Cammack Retirement Group. Cammack Retirement Group does not assume any duty to update any of the information.
Note: This feature is to provide general information only, does not constitute legal advice, and cannot be used or substituted for legal or tax advice. Opinions expressed are those of the author, and do not necessarily represent the opinions of Cammack Retirement Group.
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