Sustainable economic recovery depends on managing the pandemic
Most of us will remember 2020 as the year in which the Covid-19 pandemic infected more than 50 million people, resulted in the loss of upwards of a million lives, and caused significant suffering worldwide. We will also remember it as the year of the “great lockdown”, which resulted in an extremely negative shock for the global economy. To combat the latter, policymakers reacted in an unprecedented manner, not only providing global fiscal support of to date USD 12 trillion but also introducing extremely supportive monetary policy measures – both of which have been instrumental in preventing the current crisis from becoming an economic depression.
However, the situation is still incredibly challenging. Although the global economy experienced a strong rebound in the third quarter due to eased lockdowns and the rapid deployment of policy support, we have only seen a partial and uneven recovery. With the world now experiencing a second Covid-19 wave, in which the European and US economies are being hit particularly hard, it is clear that full economic recovery is dependent on our ability to control and cure the virus.
Our base scenario for 2021, therefore, is one of a progressive economic recovery, supported by advances in the development of an effective Covid-19 vaccine and the extension of expansionary economic policies. However, the initial rebound will be asynchronous and uneven across regions and countries. As a result, we expect to see outperformance from those countries that are best able to manage the pandemic (and that can emerge from it earlier), countries that will be in a position to provide sufficient fiscal support, and from the most flexible economies. However, the crisis is likely to leave its mark well into the medium term. Consumer spending will remain moderate for some time, particularly in the service sector and other areas impacted by social distancing. Uncertainty and balance sheet issues will impact corporate investment, and the labour market will need time to recover. Therefore, the expected rebound in global economic activity in 2021 of between +4.5% and +5%, could be followed by a more moderate growth path.
The development of an effective, reliable, and affordable vaccine will play a key role in both economic recovery and in supporting the markets. Following the recent positive news in this respect, risk assets were propelled to new highs while safe havens were sent into a tailspin. We are also observing a geographical and sectoral rotation from those regions and sectors that were best able to withstand the crisis to the laggards (e.g. growth – value rotation). This phenomenon could continue for some time, as the valuation gaps are quite significant. However, growth dynamics and the ability of sectors to generate returns, will determine outperformance ability once things begin to normalise.
2021 will also see a change of administration in the US. The split Congress should have a positive impact on the stock market, as the Biden administration is unlikely to be able to reverse the Trump tax cuts, significantly increase corporate income taxes or impose strict antitrust measures. We expect a fiscal stimulus to be approved relatively early in 2021, although the size and scope are still unclear. This would provide the US economy with a timely cash injection as the number of Covid-19 cases is increasing, as well as protect against downside risks to the economy. On the trade front, we expect the Biden administration to recalibrate the US approach with traditional partners. In the near term, we don’t expect any major changes in the US – Chinese relationship but a more reliable and programmatic approach, which should avoid reigniting the recent trade war.
Monetary and fiscal policy support will continue to be a key factor for economic performance in 2021. We expect monetary policy to remain accommodative over the long term and central banks to continue developing and using unconventional policies to achieve their targets of price stability and maximum employment. Once the economic recovery takes hold, it will be interesting to see whether and how central banks will be able to withdraw the monetary stimulus and tighten monetary policy in an environment of very high public and private debt.
In the event of a successful roll-out of a coronavirus vaccine, along with proven efficacy in the field, we expect a relatively benign scenario of synchronized global recovery for the second half of the year. Supported by expansive economic policies and the easing of Covid-19 related restrictions, this should result in a re-emergence of investors’ risk appetites and an overall positive year for the stock markets and other risk assets, including the corporate credit markets and high yields. This scenario would also be positive for emerging markets, which would see a recovery of capital inflows to their economies. We would also expect government yields to increase from the very low levels reached this year in the aftermath of the crisis. However, with low inflation, an uncertain recovery, and high debt levels, central banks will be (very) patient before raising interest rates and will avoid higher yields that could prematurely disrupt the recovery. We therefore expect only a moderate steepening of the yield curves in the advanced economies.
Ethna-DEFENSIV: opportunities for positive bond yields in 2021
In 2020, the central banks bought bonds in record volumes. This meant that the dramatic prices losses recorded by bond portfolios in March 2020 as a result of the spreading coronavirus pandemic were quickly recouped. As positive as this may initially appear, these monetary policy measures are not without negative consequences for investors, as the mountain of negative-yielding bonds already totalled USD 17.5 trillion at the end of November, an increase of 50% since the beginning of the year. As a result, there will be fewer opportunities in the bond universe in the coming year. Nevertheless, the Ethna-DEFENSIV's current bond portfolio still offers an attractive yield thanks to its robust core of high-quality corporate and sovereign bonds and a balanced mix of bonds from the high yield segment.
To refinance the various fiscal support measures, in 2021, government and supranational issuers will once again issue a record volume of bonds. At the same time, the central banks will continue to guarantee low financing costs through their purchase programmes. However, as the major corporate bond issuers will still have the considerable liquidity that they have been accumulating since March 2020 for security reasons, they scarcely need further central bank support. As a result, the issue volume in this sub-segment is likely to fall year-on-year. Overall, it is safe to say that the prices of sovereign and corporate bonds will continue to benefit from ongoing central bank purchases in 2021, even if the latter are unlikely to need this. Therefore, we expect the Ethna-DEFENSIV’s bond portfolio to generate positive returns with low volatility again next year.
In addition to bonds, which provide a source of stability, currencies should contribute to the fund's positive performance in 2021. In this regard, we are focusing in particular on the Japanese yen next year. The currency should be supported by the recently established new Asian free trade zone RCEP ("Regional Comprehensive Economic Partnership"), which at one fell swoop became the largest free trade zone in the world. According to estimates by the renowned Peterson Institute for International Economics (PIIE), the member states will benefit from a total annual GDP increase of USD 200 billion from 2030 onwards, with Japan accounting for about 25% of this. Over the long term, this should increase investment in the Japanese economy in general, leading to an appreciation of the Japanese yen.
Gold should also soon recover from its current temporary weakness. We recently reduced the gold position in the Ethna-DEFENSIV, but this has provided more leeway for a future increase in our exposure. We believe that many investors also recently traded in a similar manner, and that they will increase their positions again when prices are lower. Further interest rate cuts by individual central banks, e.g. by the Bank of England, could kick off this development.
Ethna-AKTIV: attractive asset class mix with a focus on equities
The aforementioned macroeconomic environment should provide a further tailwind for risk assets, at least for the first half of the year. In our view, the anticipated immunisation of the population against Covid-19, coupled with continued strong monetary and fiscal policy support, could even lead to a global growth surprise. Despite the price gains already posted in 2020 and the current sentiment, which is at times euphoric, we believe that this positive scenario has not yet been fully priced in. Of course, there are a number of factors that could overturn this fundamentally positive development. That is why it is important to keep a close eye on the escalating dispute over the European fiscal package and the negotiations over its US counterpart, the announcements of the central banks and, above all, the containment of the pandemic. We are therefore convinced that an attractive mix of different asset classes remains the right approach.
The Ethna-AKTIV will start the year by maintaining a high level of risk utilisation. This is primarily reflected in the fact that we have maximised our position in equities, which we believe will continue to be the most promising asset class in 2021. With a mix of growth-oriented technology stocks and cyclical companies that perform particularly well after a recession, we believe the portfolio is well equipped for this phase of the economic cycle. We remain overweight in US equities. Due to the even more promising growth forecasts for emerging markets, we are also allocating part of the equity portfolio to these regions, but are primarily using indices.
In light of the still very low interest rate environment and the historically low risk premiums, in the context of the Ethna-AKTIV portfolio, corporate bonds are becoming less important. However, the purchasing programmes of the central banks will continue to have a supportive effect, so that relatively low but stable returns can still be expected. Profits from further narrowing of spreads are likely to be offset by slightly rising interest rates when the anticipated economic recovery occurs. The average maturity of the bond portfolio will remain in the range of 5 - 6 years.
Now that the diversifying effect of bonds has been further reduced by the already very low interest rates, we are increasingly turning to currencies to spread risk. The US dollar is not the first choice for a possible phase of synchronised global growth. At current price levels, in addition to the Swiss franc we are focusing on the Japanese yen.
Although gold was somewhat weaker towards the end of the year, we still consider it a useful addition to a multi-asset portfolio due to its diversifying function. This should be particularly true in light of the still very expansive monetary policies of all major central banks. The currently neutral positioning of the Ethna-AKTIV will be adjusted upwards as soon as the positive price trend resumes. Similarly, we are also prepared to divest ourselves fully should monetary policy move in a completely different direction.
Ethna-DYNAMISCH: there are many arguments in favour of equities in 2021
Sometimes the way forward seems to be clearly mapped out. For example, when it comes to the equity market outlook for 2021. The list of supporting factors is long and impressive. After an unprecedented slump in 2020, the global economy is poised to experience a broad-based recovery next year. The base effect alone - due to the low basis for comparison from 2020, the year of the coronavirus - will ensure attractive year-on-year growth rates over the coming year. This applies equally to economic indicators such as gross domestic product, as well as to key corporate indicators such as profit and revenue development. At the same time, the equity markets are starting the new year with plenty of tailwind from fiscal and monetary policy. As a result of the central banks' continued highly expansive and unconventional monetary policy, the current low/zero/negative interest rate environment will continue to accompany the capital markets well beyond 2021. Consequently, the valuations of almost all of the asset classes have already risen significantly. This increase in valuations has also impacted equities. However, they now belong to the small group of investment securities for which, in light of the current situation, significantly higher valuations and further price potential can still be justified. Moreover, the wish for attractive returns, together with a lack of investment alternatives, is likely to attract increasingly more investors to the equity markets in the future and create corresponding demand.
A much more interesting question is which segments of the equity markets will be among the winners in 2021. For most of 2020, fast-growing growth stocks and digital crisis winners were ahead. It was only with the very positive test data on some potential vaccines in November that investors regained confidence in both low-priced value stocks and the sectors most affected by the pandemic. However, the stronger and more widespread the economic recovery in 2021 will be, the more opportunities there will be for this still fledgling trend to continue. Within our equity portfolio we aim to combine the best of both worlds. Therefore, we prefer companies that, while suffering the lockdown effects in the short term, continue to offer convincing structural growth in the long term. In short: a compelling combination of attractive valuations and fundamental growth.
Because of the excellent return opportunities provided by equities in relative comparison to the other important asset classes such as bonds, cash and gold, the focus of the Ethna-DYNAMISCH will remain on equities in 2021. All the other investments mentioned also have their place in the portfolio - in no small part for diversification reasons - but will probably only be used as a supplement and with a lower weighting.
We consider the positive equity market scenario outlined above to be the most likely and are strategically positioned accordingly. Nevertheless, with the high flexibility of the Ethna-DYNAMISCH, we are also ideally equipped to deal with alternative scenarios - as we have already shown in 2020. This applies both to the allocation of asset classes and to the selection of single stocks in the portfolio of ETHENEA's most offensive multi-asset fund.
In 2021, as in previous years, we will use the flexibility inherent in the Ethna Funds to make optimum use of the multiple benefits of an actively managed multi-asset portfolio.
Please contact us at any time if you have questions or suggestions.
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