An elusive return to normal

Investors will most likely remember two main things about the state of financial markets in 2020. The first is that they violently yoyoed. After initially panicking at the sight of governments wilfully inflicting untold economic damage in a bid to arrest a pandemic veering out of control, investors gradually realised that such a deliberate move to engineer a slump would necessarily be accompanied by monetary and fiscal support commensurate with the collapse at hand – in other words, inordinately large. The second memory investors will come away with is the stark contrast in performance between winning and losing sectors. For portfolio managers to make it through this unprecedented period, it was imperative to actively manage market risk and to go about picking stocks and bonds with the utmost discipline.

The extraordinary fiscal relief rolled out by governments and the monetary-policy support provided by central banks have shown an outstanding degree of coordination in 2020. Necessity being the mother of invention, long-standing commitments to a modicum of economic orthodoxy have been temporarily put on the back burner. However, a return to broadly normal conditions inevitably raises the question of where public policy will be heading.

On the fiscal front, it is already apparent from the way the European Union’s institutions operate that even just a few unyielding member states – Hungary and Poland at this point – have the means to block rapid implementation of the EU Recovery Plan. In the United States as well, it’s anyone’s guess as to how much cooperation the incoming Biden administration can elicit from the Senate. A Democratic majority in the upper house is still an arithmetic possibility if both of the party’s candidates in Georgia win on 5 January. But the opposite outcome is at least as likely, and a renewed Republican majority could well make a point of rejecting the administration’s key Federal spending proposals, as happened to Barack Obama in 2010–2011.

It will take a long time for even a robust upturn to repair the colossal damage done to the economy in 2020

Besides this manifest lack of clarity on future policy, there is a very real risk that, as today’s exceptional circumstances recede, the conventional advocates of fiscal restraint will come back to the charge. And while we can reasonably expect large-scale vaccination to give a hefty boost to confidence, travel and consumer spending, watered-down stimulus programmes will almost certainly have the opposite effect. In our view, markets are so busy celebrating a return to normal that they might be overlooking the obstacles to growth that are still very much with us, particularly as global debt and underemployment have both risen further. It will take a long time for an upturn, however robust (if only due to a favourable comparison basis), to repair the colossal damage done in 2020 to a world economy already hampered by weak secular growth. To be sure, the possibility that across-the-board central-bank largesse will eventually trigger a sharp increase in inflation can’t be ruled out entirely. But we feel that the currently forecast cyclical recovery should not be mistaken for a trend reversal at this stage. Destruction will not be creative in the short run – assuming it ever is.

For all those reasons, we will be sticking with our bias in favour of quality growth stocks, though we are also happy to see that, after patiently waiting for their chance, companies exposed to the re-opening of the economy can at long last contribute to our returns again.

It’s worth noting that, even if fiscal spending is restrained, the fallout from the 2020 economic shock will still include considerable funding needs for governments, whose huge deficits will make it impossible for them to get along unless their central banks back them up. As long as the latter maintain their unstinting support, we are unlikely to see a surge in bond yields – a development that would spell trouble for government budgets in most countries.

Be that as it may, within the fixed-income space, we continue to favour corporate bonds, provided they offer decent and reliable yields. Sooner or later, however, unlimited central-bank support might end up undermining the intrinsic value of currencies when money gets printed for no other reason than to finance deficit spending. The US dollar seems particularly in danger of falling victim to such a fate. On the upside, a weaker greenback would ease financial conditions for countries that borrow and trade extensively in dollars – first and foremost emerging economies. In China’s sphere of influence at least, that boon would come in addition to the region’s two key advantages: skilful handling of the public health crisis, which has paved the way to a swifter economic recovery; and an enviable presence across major new technology segments, including alternative energy (above all in electric vehicles).

The emerging world enjoys two key advantages: a swifter economic recovery and an enviable position in high-growth sectors

It also seems to us that a possible slide in the dollar, and perhaps other currencies confronted with similar challenges, could put gold back on its upward trajectory in 2021.

To conclude, as the world emerges from the “anomaly” experienced in 2020, sectors unduly hurt by the crisis should soon be back to more normal valuations. But beyond that adjustment, it is important to keep in mind that with regard to equity-market performance, long-term earnings growth will remain the ultimate judge and jury. As we pointed out in our October Note (“How 2020 is changing the game”), with interest rates set to stay rock-bottom, the world economy still sluggish and macroeconomic imbalances getting worse, earnings growth will remain scarce – and fragile even when it does occur. We will therefore continue to construct our global portfolios around four key “antifragile” types of assets: shares of companies with predictable profit growth, China and its broader regional sphere of influence, winners in the energy transition, and gold miners.

Source : Carmignac, Bloomberg, 30/11/2020