2021 Investment Outlook: Riding The Road To Recovery

2020 was an unpredictable year

2020 was an unpredictable year with a black swan event “Covid-19 pandemic” that drove the global economy into the deepest recession since WWII. What is interesting about the financial market is that we saw the steepest and quickest bear market decline ever, followed by the fastest rebound ever to conclude the year at all-time highs, thanks to the “whatever it takes” monetary and fiscal stimulus, as well as positive vaccine news.  

Vaccine is the key catalyst

The whole world is keeping a close eye on the development and roll-out of the Covid-19 vaccines, as this will likely indicate how the economic recovery would look like in 2021. The positive newsflow on vaccines, especially the higher-than-expected efficacy rate (above 90%), has triggered a great rotation from growth to value/cyclical stocks in recent months, as we had expected and highlighted in our September 2020 Investment Navigator “Well Done Tech: Time To Hand Value The Baton”. With global equities now at fresh record highs, the key question is whether the rally is sustainable? 

Is sentiment getting too bullish?

A number of sentiment indicators show that investor sentiment is getting more bullish but not at extreme levels yet. For example, cash level held by asset allocators has been declining quickly in recent months and many are underweight cash for the first time since May 2013. We also see all-time record inflow into global equities with equity allocation near record high.

Some sentiment indices had been concerning at end-November, with the CNN Fear & Greed index at an “Extreme Greed” reading of over 90. However, the index has returned to a Neutral (52) level at the start of January.

We would not be surprised that any negative news could trigger market corrections at any time sooner or later. Nevertheless, market volatilities are good buying opportunities to position for a cyclical recovery in 2021. 

“Goldilocks” scenario

2021 could turn out to be the strongest global recovery in a decade if vaccine roll-out plays out as expected, major central banks stay “put” and fiscal stimulus is implemented as planned or even additional fiscal support is on the pipeline. When deflation is now still a key risk to the major economies, we expect a reflation story in 2021, rather than any hyperinflation worries. This looks like a “Goldilocks” scenario (not too hot, not too cold) for global economies, which is very supportive to a bull market.

Position for a cyclical recovery

We upgraded some pro-cyclical sectors such as materials and industrials over the course of 2020 to play the great rotation. We also made several changes in recent weeks to position for a strong global cyclical rebound in 2021:

• Upgraded Japanese and UK equities to positive

• Downgraded US equities to neutral (the Big 5 tech companies are at or reaching their cycle-high profitability and valuations)

• Upgraded US and Europe real estate sector to positive

• Upgraded Asian utilities, material and industrial sectors to positive

10 Investment Themes for 2021

We are optimistic that 2021 will be a year riding on the road of robust economic recovery, although it could be a bumpy ride during the journey. Too slow growth could trigger recovery and deflation concerns, while too strong growth could lead to inflation worries as well as sharper-than-expected rise in nominal and real yields which are the key risks.

Overall, a “goldilocks” scenario would be a favorable environment in particular for equities, credit, commodities and real estate. Our 10 investment themes for 2021 include one short-term tactical theme to play the key macro outlook in 2021; three medium-term balanced themes to offer more defensive solutions in a low interest rate environment; four long-term structural megatrends themes with one related to the further opening up of China and the others about new consumption behaviors, improving quality of life and smart technologies; and the last two are long-term ESG (Environmental, Social and Governance) themes on renewable energy/green deal, and investing in companies with strong governance plus high profitability. 

GDP & CPI Forecasts

GROWTH

• Vaccines have become available early December but the distribution is slow. We expect economic activity to strongly benefit from it in Q2 and thereafter.
• In China, activity had already returned to above pre-pandemic levels and it should stay strong in 2021 (+8.6% GDP).

INFLATION

• Inflationary pressures should remain generally weak over 2021-22 across both advanced and emerging economies.
• However, once the cyclical downward pressure on inflation fades, inflation will gradually rise to levels consistent with central targets, especially in the US.

Equity

• Upgraded Japanese equities to positive in December amid the market’s pro-cyclicality, rising profitability levels and attractive valuations.
• Downgraded US equities to neutral last month, mainly because the Big 5 tech companies are at or reaching their cycle-high profitability and valuations.
• Upgraded UK equities to positive in early January given the successful conclusion of Brexit trade negotiations.
• Turned positive on US and Europe real estate last month, seeing the sector as a play on “the end of stay at home”.
• In Asia, upgraded utilities to positive in December and further upgraded materials and industrials in early January as rotation from growth to cyclical/value/dividend to continue in 1Q is expected.

Fixed Income

• Stay positive on US IG corporate bonds, with a preference for duration at benchmark (8.7 years). Despite the Treasury Secretary ending some facilities, the safety net has not completely disappeared. Fundamentals have also turned out to be better-than-expected.
• Neutral on US high yield. Yields are decent in a yield-starved world but spreads are not attractive. We are however positive on fallen angels as they usually enter the HY space with larger spreads than existing BBs, and should continue to perform in this search-for-yield environment.
• Turned positive on EM debt in hard currency in December: The Covid-19 vaccine, a new US government, higher domestic demand in China and pro-cyclical financial conditions bodes well for the asset class. Furthermore, a low US real yields and a weaker dollar acts as a tailwind for EM bonds in hard currency.
• Revised upwards our 10-year and 30-year yield targets for US Treasuries to 1.40% and 1.9% respectively last month as economic rebound will raise inflation expectations and the term premium. 
  

Forex & Commodities

USD: The Fed’s shift to average inflation targeting is likely to push up inflation expectations, even as Fed purchases continue and forward guidance continue to cap nominal yields. The resulting decline in real yields is supportive for risk sentiment and consistent with a continued depreciation of the USD. Our 12-month target for USD Index is 88.2.

CNY: The economic recovery is expected to accelerate later this year which should fuel global trade. Moreover, the expected global dollar weakness should support the USDCNY. Given the strong appreciation of the yuan this year we think it should come back its 50d moving average at 6.6 over the next 3 months. Over the next 12 months, we keep our target at 6.5.

GOLD: Vaccines may solve the sanitary crisis but the economy will still struggle with bankruptcies and high debt levels requiring central banks to keep their ultra-loose monetary policies for quite a long time. Negative real interest rates, USD weakness and inflation fears would bring back gold prices above $2000 in 2021.

OIL: Further demand recovery should support prices as the year progresses. Excess capacities will cap prices in 2021 but the outlook for 2022/23 is bullish due to the lack of investments in the recent years. We expect Brent prices to remain in the $45-55 range in the first half of 2021 and $50-60 in the second half.

Strategic & Tactical Allocation

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