Capital Markets Update

• Looking back over the year
• Our "base case" for 2021

Looking back over the year

What a strange year 2020 has been. Thinking back to January the world was naive as to what was about to hit. We expected the global economy to fare relatively well this year. However, Covid-19 forced us to completely re-evaluate the economic reality. The year started amid Trump’s impeachment controversy and the signing of a trade agreement between the US and China. By the end of the month, Covid-19 had entered investors’ radars, but consensus thinking was that it was likely to be a regional issue with China aggressively taking action to combat the disease.

Focus then moved onto the US democratic primaries with a lot of attention on the socialist agendas that we haven’t seen in the US in recent history. However, by late February and early March slowly saw the world wake up to the realisation that Covid-19 was a serious disease, and more importantly, going global. We saw Italy declare the first national lockdown on the 9th March as it became clear that Covid-19 was present in all major regions around the world. Markets very rapidly shifted into fear mode, with a flight to government bonds and all equity indices plummeting. As more cities and countries entered into lockdowns the fear in markets intensified, culminating in evaporating liquidity even in government bonds. This forced a response from the Fed. On the 15th March Jerome Powell announced interest rate cuts and emergency Quantitative Easing (QE). Within a week, equity markets had found their bottom and liquidity returned to bond markets.

Fiscal stimulus packages from governments across the globe followed and April saw a huge resurgence as markets took the view that governments and central bankers would do whatever it took to prevent widespread financial distress. So far, it appears to have worked. Bankruptcies have happened, but at a relatively modest rate, lower bond yields have allowed companies to refinance debt and bolster balance sheets in what has been a blockbuster year for debt issuance. Households and companies are, on aggregate, awash with cash. Governments however are more indebted than ever. The debate around national debt, whether it needs to be repaid or can continue to grow indefinitely referred to as ‘modern monetary theory (MMT)’ is no longer an academic question. Much of the developed world has signed up for this experiment. The unintended consequences and ultimate conclusions remain unclear but hotly debated.

Summer saw a continued rally in equities, particularly growth and technology names that were perceived to benefit with interest rates pinned to the floor. For example, Zoom had quadrupled its share price by July and doubled again before its peak in October. Other growth stocks captured headlines, Tesla being the most notorious and eventually becoming the fifth largest listed US stock, just behind Facebook and larger than Toyota, GM and Ford combined. Joe Biden was selected as the democratic candidate for president which was seen as positive for markets.

September and October were much choppier in terms of market action as we saw a second wave of Covid-19 building across western economies leading to fears of further lockdowns. Of course, these fears proved well founded but the sheer volume of monetary and fiscal action seemed to keep markets rangebound, even as uncertainty increased leading into an increasingly bitter campaign with Trump calling out voter fraud at every opportunity, even before the first ballot was cast.

November saw the election of a new US president in Joe Biden, almost certainly helped by President Trump’s less than stellar response to Covid-19. However, the US senate remains under Republican control. this was touted as the ‘worst case’ outcome for markets on fears that further fiscal stimulus would not be able to pass political gridlock. However, markets reacted positively and news of the first Covid-19 vaccines passing their phase III trials added fuel to the rally, triggering the strongest run-up in stocks since April.

Despite all that has unfolded, major equity markets such as the S&P500 and the MSCI World have hit record highs, although more ‘value’ focused markets such as the UK FTSE All Share Index and the Eurostoxx remain in negative territory for the year.

Our "base case" for 2021

The economic outcome in 2021 will be better than that of 2020 but we should not immediately expect that any economic improvement will translate into an easy backdrop for financial markets.

Looking forward to 2021, a huge question in investors’ minds is whether the massive scale of QE with the addition of unprecedented fiscal stimulus prove inflationary which could prove very problematic for central bankers in coming years. Or has the demand for capital structurally reduced, leaving deflation as a big economic threat with very little in the way of ammunition to fight it? Either outcome is plausible but have very different ramifications for asset prices and where investors should look for future returns. If you’re in the inflationary camp, value equities and real assets like property look very attractive here. The deflationary view has long duration and growth equities as a more enticing proposition.

With vaccines on the way it’s easy to see things improving economically but as we’ve seen this year GDP and asset prices often do not correlate well. So, while we believe that accommodative policy will support markets, it is important to cast your net as wide as possible.

We wish you and your families a happy and healthy end to this year and all the very best of luck for the year ahead.

Important information:

The value of an investment, and any income from it, can fall or rise. Investors may not get back the full amount they invest. Past performance is not a reliable indicator of future results. Personal opinions may change and should not be seen as advice or a recommendation.