Global Market Outlook 2021
2020 was a year of surprises. There was the speed at which the pandemic escalated, the severity of the lockdowns, the size of the government stimulus measures globally and the magnitude of the equity market rebounds. Perhaps the biggest surprise is that global equities, as of late November, have gained around 12% since the beginning of the year—an outcome few would have predicted during a global pandemic. With the U.S. election behind us and effective vaccines on the way, investors have become bullish, pushing the S&P 500® Index to record highs. Likewise, we have a positive medium-term outlook for economies and corporate earnings. We’re in the early post-recession recovery phase of the cycle. This implies an extended period of low-inflation, low-interest rate growth that favors equities over bonds. There are some near-term risks, however. Investor sentiment has become overly optimistic following the vaccine announcements, markets vulnerable to negative news. This could include renewed lockdowns in Europe and North America as virus cases escalate, logistical difficulties in distributing the vaccine and negative economic growth in early 2021 if government support measures are unwound too quickly. Geopolitics could also deliver negative surprises from China, Iran or Russia as the new Biden administration takes power in the U.S. Our cycle, value and sentiment (CVS) investment decision-making process scores global equities as expensive (with the very expensive U.S. market offsetting better value elsewhere), sentiment as overbought and the cycle as supportive. This leaves us slightly cautious on the near-term outlook, but moderately positive for the medium-term with expensive valuation offset by the positive cycle outlook.
Overall, we see the following asset class implications for 2021:
◆ Equities should outperform bonds.
◆ Long-term bond yields should rise, though with steeper yield curves likely limited by continued low inflation and central banks remaining on hold.
◆ The U.S. dollar will likely weaken given its countercyclical nature.
◆ Non-U.S. equities to outperform given their more cyclical nature and relative valuation advantage over U.S. stocks.
◆ The value equity factor to outperform the growth factor.
A return to normal by the second half of the year should help extend the rotation that began in early November away from technology/growth leadership toward cyclical/value stocks. During the COVID-19 pandemic, technology and growth stocks enjoyed tailwinds from a boost to earnings and lower discount rates. These tailwinds should become headwinds once a vaccine is available and lockdowns have been eased. This should allow the normal early-cycle recovery dynamics to resume, with investors rotating towards relatively cheaper value and non-U.S. stocks that will benefit from the return to more normal economic activity.
The major economies have escaped the pandemic and lockdowns with relatively little long-term economic damage thanks to substantial monetary and fiscal support. Wage subsidies and job retention schemes have prevented unemployment rates from rising significantly in most countries. In the United States, corporate bankruptcies and delinquency rates on consumer loans were lower in the September quarter than the same period in 2019. The hospitality, tourism, transport and retail sectors have been hit hard, but the overall balance sheet damage to corporates and households has been relatively limited despite the large lockdowns.
The most notable damage from the pandemic is rising government debt. The International Monetary Fund (IMF) projects that gross government debt for the G71 economies will rise by 23% of gross domestic product (GDP) in 2020. High debt makes government finances vulnerable to rising interest rates. This is unlikely to be a significant problem in the next couple of years, but it will matter when spare capacity is eventually exhausted, and inflation starts to rise.
There is speculation that governments will soon start to trim deficits through tax hikes and lower spending, slowing the recovery. This seems unlikely anytime soon. The two charts below show that despite the increase in debt levels, net interest expenses are projected to trend lower for all the major economies. By 2023, Japanese government net interest payments are expected to be close to zero, despite gross debt in excess of 250% of GDP. Two-thirds of Japanese government debt has a negative yield.
Governments will come under pressure to reduce deficits only after bond yields rise meaningfully and markets question debt sustainability. We expect fiscal austerity and tighter monetary policy are still some years away.