2021 INVESTMENT THEMES UPDATE

What now, following an impressive run since November 2020?

Faster nominal growth expected: with Covid infection rates falling quickly in the US and the vaccination programme proceeding well, the US economy should re-open in the very near future, thus boosting consumption and services demand to add to the existing strength in manufacturing activity.

The vigour in US residential construction remains another bright spot in the US, which together with expectations of the passing of a further programme of fiscal spending by the Biden administration are contributing to a consensus US GDP growth forecast that has risen to a heady 4.9% for this year..

Markets expect higher inflation in future: in addition to the strength in both US and Chinese economic growth, higher future inflation is now seen both by US consumers and the bond market, with 10-year US breakeven inflation priced into Treasuries at 2.2%, i.e. its highest level since 2018. Similarly, in Europe medium-term inflation expectations have risen to 1.4%, their highest level since mid-2019.

Commodities in a new supercycle? One of the biggest contributors to higher expected inflation is the progression of commodity prices, with energy, metals and food prices all substantially higher than in many years. By end-February, the Continuous Commodity index had rallied to its highest level since end-2014, up 47% from March 2020 lows. The recovery in demand from robust global economic growth, combined with structural growth for industrial metals from renewable energy infrastructure and electric vehicles, and finally constrained mining supply are a potential cocktail for a new commodity supercycle, while Chinese commodity demand remains vigorous. Commodity exposure thus remains one of our strongest convictions at an asset class level, and an excellent way to play the reflation theme.

Yield compression everywhere! In spite of the recent rally in the US Treasury 10-year yield to over 1.4%, we should keep in mind that this level remains lower than at any point prior to 2020.

In Europe, the Italian 10-year BTP bond yield has fallen to 0.7%, again lower than at any point prior to October last year.

Corporate bonds are hardly better: even the lowest level of European Investment Grade corporate bonds (BBB rating) offer a measly 0.55% yield; again, close to the lowest level of yield ever seen for this credit rating. Central banks are the principal cause of this compression in yields with their Quantitative Easing bond-buying programmes – but this state of affairs is very likely to remain for the foreseeable future.

What is a risk-averse, income-seeking investor to do in such a low-yield environment? This is the question we tackle in our second theme, focused on low volatility absolute return solutions for investors, via a variety of funds and structured products.

Strong residential real estate demand: the ongoing ultra-low yield environment should provide a strong support for the real estate asset class, notably for residential housing demand globally. In the US and most of Europe, there is an ongoing shortage of housing stock to buy or rent, while long-term mortgage rates have sunk to historic lows. The average French mortgage rate (for mortgage durations of over 1 year) sits at 1.2%, compared with an average of 3.2% since 2003. Unsurprisingly, US house prices have accelerated, rising 10.4% year-on-year by end-2020.

Pent-up consumption to be unleashed: the combination of huge excess cash savings built up over 2020, extra stimulus cheques to be sent to US households plus the wealth effect from rising stock and housing markets should all contribute to a boom in domestic consumption once current restrictions are eased worldwide. This should be led by the US, China and the UK, with Continental Europe following soon after. We look to gain exposure to this boom in consumption via our new consumption theme: “Consumers are ready to splash out”.

Edmund Shing, PhD