Monthly Market Commentary: January 2021 – Record Differentials

Global equities returned nearly 5% in December, making a Q4 total of 15% in local currency terms. However, for UK based investors, sterling’s appreciation to $1.37 on dollar weakness and the Brexit trade deal reduced this to 9%. A change in sector leadership helped the FTSE 100 rise nearly 600 points to 6,460 while more economically sensitive medium and small companies were up 18% and 23%, respectively. Asian markets were notably strong over the quarter.
The global equity return in 2020 was 14% but the UK fell 10% – the largest differential ever recorded. The US and Asia Pacific (+17%) outperformed with emerging markets gaining 12%, Japan 11% and Europe 9%. This principally reflected higher valuations rather than increased profits or dividends. Globally, profits fell around 14% with a marked difference between developed and emerging economies as well as intra-region. China, Korea, Taiwan and India recorded earnings per share increases between 10%-25%. While US earnings (-10%) fared relatively well, the Eurozone was down 28% and the UK down 34%.
There were also widespread gains in fixed income as further quantitative easing measures and asset purchase programmes combined with rising equity markets saw investment grade credit generally perform better than high yield credit and government bonds. Longer-dated index-linked outperformed. The UK 10-year gilt yield declined 60bps and closed at 0.2% – close to its 2020 low. Economically sensitive commodities like copper rose as the outlook improved but the sharp contraction in global trade and lack of production discipline meant that, despite strong H2 gains, Brent crude ended the year down 26% at $51. Gold closed higher as investors sought an event risk hedge and an alternative to bonds where yields are, in some cases, negative.
Financial markets started the year expecting “Phase one” of the US/China trade deal to extend an uninterrupted ten years of global economic growth. However, within two months, coronavirus had begun to spread rapidly with the World Health Organisation declaring a pandemic in mid-March and government shutdowns of businesses and non-essential activities triggering the steepest global recession in generations. Trade grounded to a halt and job losses accelerated although unemployment rates in many countries were flattered by furlough schemes and other income support measures. The economic collapse would undoubtedly have been far greater were it not for central banks’ unprecedented monetary policy response and government fiscal rescue packages with the latter pushing the ratio of public debt to GDP over 100% across the OECD.

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Despite the economic trauma and dramatic swings in sentiment, equity markets rebounded from the March meltdown until concerns about a second wave in early September raised doubts about the sustainability of the recovery. After a period of rising volatility ahead of the US election in early November, the outcome – albeit contested by President Trump – combined with further monetary and fiscal stimulus and positive vaccine news resulted in a strong year-end rally with some markets reaching new or multi-year highs. Given the year-end backdrop of a new strain of the virus, accelerating infection rates, record hospitalisations and deaths, investors appear to have placed unquestioning faith in the vaccine solution even though the logistics of mass inoculation mean herd immunity is unlikely to be achieved before Q4 2021.

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Global GDP is expected to have declined by 4% in 2020 with a significant gap between advanced (-5.4%) and emerging economies (-2.2%). China (+2.2%) was the only major economy to grow in 2020 but the US (-3.4%) fared relatively well against Japan (-5.1%), the Eurozone (-7.3%) and the UK (-11.2%). Consumer services were particularly hard hit during the pandemic and continued to contract in Q3 so – while recovery can be expected in 2021 – this will be asynchronous and the global economy may not regain 2019 output levels, let alone revert to trend, until mid-2022. Short-term estimates are little changed and positive vaccine news has been largely offset by the as yet unquantifiable impact of second and possibly third waves in tandem with growing unemployment. China is leading the recovery with the US seeming likely to follow but the timeframe for the Eurozone and UK has been extended – not least because the last minute Brexit deal is expected to mean less certain trading access and frictional costs.

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The pandemic recession, lower oil prices and higher unemployment resulted in low consumer price inflation (CPI). Notably, advanced economies which recorded CPI figures of 0.7% were significantly below the 2% global average and central bank targets. As it will take several years for many to return to trend growth, a sustained pick-up in inflation appears unlikely although further lockdowns could distort 2021 data. While some investors fear that financial asset and housing inflation will feed through more directly, we expect the bursting of these bubbles to weaken future growth rather than increase CPI – Japan being an obvious precedent.
In developed markets, technology was the best performing sector with US technology indices – dominated by a handful of transformative digital companies – rising over 40%. Towards the end of the year, there was some rotation from growth/momentum/quality towards cyclical/ value that helped industrials, especially in Europe and Japan, as well as financials and energy. Higher yielding equities had a particularly challenging year – notably in the UK where a combination of dividend suspensions and significant resets meant income fell by around one-third.
The magnitude of the economic collapse, the policy response and the launch of vaccine programmes have set the scene for a significant recovery in 2021. While equities continue to look the best value as bond yields are so low, a degree of caution appears warranted with sentiment and positioning indicators suggesting over-euphoria at the prospect of the start of a new economic cycle.

Written by

Duncan Gwyther
Chief Investment Officer

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