Trends in global markets

We are witnessing extremely challenging times where cries of help, death and destruction are interspersed with financial troubles, inflation and yet progress, lives empowered by new technology, AI, new drugs and healthcare solutions.

The need for dominance (technological or otherwise), power play, regional conflicts and historical conflagrations are making for death, destruction, unstable geo politics, mistrust amongst trading partners, high inflation, energy shocks, human cost and displacement. Will this not impact your investments?

Here is a closer look at some key trends shaping our future.

Conflicts, Geopolitics and Volatility

‘This may be the most dangerous time the world has seen in decades and ongoing war in Ukraine and conflicts in the Middle East may have far reaching impacts on energy and food markets, global trade and geopolitical relationships’, said Jamie Dimon in a recent statement.

Central banks responded to the high inflation with the most aggressive global rate-hike cycle in decades; resulting in tighter credit, higher costs of doing business and forecasts of an impending recession.

Global debt has already hit a record $307 trillion in 2023. Experts predict more volatile business cycles, constraints on supply, shortfalls of demand and labour market shifts leading to economic fluctuations.

A bumpy economic landing seems inevitable as the economy sputters along; 6 out of 10 chief economists expect the global economy to weaken/ slowdown this year, as per the WEF.

As per this PIMCO report, ‘……..with the era of volatility-suppressing policies possibly over, markets are likely in for a period of heightened volatility, with an unusually large array of potential aftershocks.’

We would certainly do well to BUILD IN VOLATILITY into our investments decisions.

There are also reports of a drop in card spending in the US. Credit card spending was seen to be soft in September, across all sectors. ‘I think we are starting to see growing financial strain at the lower end of income levels’, said Citigroup economist Robert Sockin.

US – CHINA relations

The ever evolving US – China dynamic amidst the race for tech dominance continues to be at the cornerstone of geopolitics. This continues impacting the future of many corporations, such as NVIDIA due to the tighter restrictions on exports of hi tech items such as AI powered chips.

China is a larger story in itself. The slowdown and competition in China is beginning to impact the fortune of companies such as LVMH, Starbucks, Nike, Apple, Tesla, Rolex amongst others.

Barrons and The Wall Street Journal have reported these as impacted companies.

‘CASH is far from TRASH’

Last year was painful for fixed income investors in 2022 as they suffered losses on the back of rising interest rates. Higher interest rates have made holding cash more attractive, with many popular fixed-rate accounts paying over 5%.

Some banking stocks such as Bank of America and Goldman Sachs have benefitted from higher NII (net interest income) during this cycle of high interest rates.

Technology, Innovation, new DRUGS

In his recently published 7 page letter, “The Age of AI has Begun”, Bill Gates said that ‘The development of AI is as fundamental as the creation of the microprocessor, the personal computer, the Internet, and the mobile phone. It will change the way people work, learn, travel, get health care, and communicate with each other.’

Of particular interest are breakthroughs in AI, ML, Metaverse and VR (virtual reality), unlocking huge value across the business spectrum…. especially in healthcare, cybersecurity and semiconductors. There is a quiet convergence taking place – providing the grounds for a hyper connected, data driven world.

Recent drug discoveries and treatments in the areas of obesity, diabetes management, cervical cancer are heartening as they cater to huge markets.

Conclusion

‘Markets seem to be pricing the best of all worlds – inflation moderating, policy rates falling, and recessions evaded……. while attractive, the yield provided in ultra-short fixed income may be fickle, and kicking the can down the road on strategic allocations could prove costly for investors’, according to Goldman Sachs.

The key risk factors point to slower growth on the back of higher interest rates, ageing constraints for the workforce, geopolitical fragmentation of supply chains, technology led opportunities and disruptions. Mega forces are creating opportunities and risks across sectors and regions.

Yet, most agree that risks to growth are skewed to the downside and returns across asset classes are likely to be more differentiated.

© Anu Maakan October 2023

A closer look at Consumer Discretionary spend

Investing in Consumer discretionary stocks helps us profit from increases in our own non-essential spending as consumers.

Since consumer spending is something we possibly understand better than corporate spending, it makes this a very attractive sector to have a closer look at.

Demand for discretionary goods is cyclical and tends to rise and fall with the health of the economy. It is usually the first to suffer when we cut back spending on electronics, travel, durables etc. This makes these stocks more volatile compared to essential service providers.

Be it luxury, durable goods, home electronics, luxury, automotive, travel, leisure, entertainment – some of these companies command strong brand loyalty and premium pricing, with an ability to adopt dominant positions in their space.

Current economic scenario

The current economic landscape looks like this:

• Upward trends in wages and wage linked inflation in most of the US, Asia and parts of Europe.

• An environment of high interest rates and inflation leading to rising cost of products and services, thereby making a bigger dent in our savings.

(This is not ideal for the sector, as they make their money from consumer spending, and low interest rates usually stimulates spending. Between Dec ‘08 and December ‘15 — the Consumer Discretionary Select Sector SPDR Fund (XLY), rose more than 280% and outperformed the S&P 500 index, due to the near 0 interest rates).

• Most industry pundits are not predicting a recessionary environment, rather keeping a tight leash on super high growth via interest rate hikes.

Does this support growth of the consumer discretionary sector?

S&P500 Consumer Discretionary constituents and performance

The consumer Discretionary sector is approx. 10% weighting of the S&P500. It is the fourth largest segment after Information Technology, Healthcare and Financials.

Its performance has been leading the overall S&P500 performance and has provided 31% returns YTD, -37.58% in calendar year 2022, 24.2% in 2021, 32.07% in 2020, 26.2% in 2019 respectively.

Due to economic concerns linked to rampant inflation, lower purchasing power, and higher interest rates, the consumer discretionary sector displayed weak performance in 2022, as investors avoided cyclical sectors. However, the outlook improved in 2023.

Key Risks

• Consumer discretionary stocks can be significantly affected by the performance of the overall economy, interest rates, competition.

• This sector is also exposed to changes in consumer demand, consumer confidence and spending, changes in demographics and buying patterns.

• Rising input costs, including higher wages, can cut into margins or force companies to raise prices, which could reduce sales.

• Retailers and manufacturers of consumer discretionary goods are susceptible to supply chain disruptions, especially those with sprawling networks of suppliers.

Key factors to consider

Inflation has been high for a few quarters now and there is no sign of interest rate cuts just yet. This is not an ideal environment for the sector and some stocks have lost value together with the overall market.

Top holdings within S&P500 Consumer Discretionary by index weight are: Amazon, TESLA, Home Depot, McDonald’s, Lowe’s, NIKE, Booking Holdings, Starbucks, TJX Cos Inc, O’Reilly Automotive.

BofA Securities has recently upgraded consumer discretionary stocks from “underweight,” to “overweight”. Some of this optimism is based on expectations of a soft landing for the U.S. economy, improved revenue and earnings beats (relative to consensus analyst expectations) than the staples sector and credit/ debit card data showing that demand for goods is recovering, particularly for big-ticket items like homes and cars.

Some companies in the sector have shown strong growth and growth of new segments.

For instance, Lululemon Athletica, McDonalds and LVMH reported strong Q2 2023 results.

The sports apparel company had total revenues of $2.2 billion, up 18%, surpassing Wall Street estimates. McDonald’s reported second-quarter net income of $2.31 billion, up from $1.19 billion, an year earlier. Others such as Home Depot did not impress wall street and provided a negative guidance for 2023-24.

Until the economy shows strong growth and inflation starts to taper, stocks in the sector will carry some risk. The key will be to perform stock level analysis and pick stocks with a strong value proposition and growth, strong guidance and with reasonable current valuations.

Therefore, stock level analysis and risk assessment will be critical before making a purchase decision.  

The most popular ways to invest in the consumer discretionary sector are individual stocks, ETFs or Mutual funds.

© Anu Maakan September 2023

The weakening case for equities amidst bank failures

HSBC is buying out the UK subsidiary of S.V.B. (Silicon Valley Bank) for £1. Yes!

Something must have gone seriously wrong? Yes!

Explained simplistically, S.V.B. invested large sums into long-dated securities. With the Fed’s drive to increase interest rates, its investments began to lose value and investors started to pull out funds. It was also functioning without a head of risk for several months.

Federal regulators have announced that all customers of both SVB and Signature Bank would have access to their money. The immediate turmoil in the US banking sector seems to have been arrested.

This episode raised additional questions for the sector. Are there other banks vulnerable to interest-rate risk? Will the acquiring institutions be as friendly to start-ups as S.V.B.? Who will start-up founders trust with their money….. and will they continue to be funded as before?

Let us not forget the underlying issues forces that led us here:

• The Fed’s unrelenting focus on bringing down inflation via increasing interest rates (and hence the reduced valuation of bank stocks).
• Poor risk management practices at some banks.
• Reduced regulatory scrutiny on banks, following on from Trump’s populist era.

Jim Reid and a team of strategists at Deutsche Bank explained, ‘SVB’s woes are a combination of one of the largest hiking cycles in history, one of the most inverted curves in history, one of the biggest bubbles in tech in history bursting, and the runaway growth of private capital. ………. it’s just more of the boom-bust cycle we’re stuck in.’

In the aftermath of the 2008 financial crisis, Congress passed the Dodd-Frank Act to protect consumers. Wall Street chief executives, their lawyers and lobbyists spent millions trying to defeat it. Greg Becker, the chief executive of S.V.B. was one of them.

Biden has started to talk about bringing back more banking regulation!! When will those kick in? What will they entail?

Bank runs are considered quite dangerous because they may induce panic and concern amongst customers about their own deposits. In an interview on Sunday, former FDIC chairman William Issac said ‘there’s no doubt in my mind: There’s going to be more. How many more? I don’t know.’

There are big clues that there’s more pain to come, look to the market. There is potential for a cascade of bank failures, reflected in their shares prices on Monday.

First Republic, PacWest, Western Alliance, and Charles Schwab are among the major names that sank on Monday as investors grew anxious about banks’ ties to the tech industry and their massive unrealized losses. According to the FDIC, at the end of 2022 US banks were sitting on $620 billion in unrealized losses on their bond assets. 

Moody’s Investors Service has downgraded the ratings of the collapsed Signature Bank to junk. It has also put the following six banks under review – First Republic Bank, Zions Bancorp., Western Alliance Bancorp, Comerica Inc, UMB Financial Corp and Intrust Financial Corp.

A volatile future!

Does the global economy remain a fundamentally sound place? Will there be more surprises in the stock markets?

Equity investing seems to have gotten more complicated and vol. Some factors to consider:

• What about escalations in the Russia-Ukraine war and its impact on supply chains and cost structures across the world?

• Will the inflationary risk and interest rate risk spill over to other sectors?

• Could there be an impending funding crisis for technology companies/ start ups?

• What about the impending recession, cost increases and unemployment resulting from central bank policy?

• Could political tensions mount, especially that of US-China and in South Asia under China’s growing need to show dominance?

There seems to be a more stock market volatility coming our way and certainly not the tail end of bad news.

© Anu Maakan March 2023

Results speak!

Some of us have bid farewell to that exotic holiday, the new vehicle, yet others have cut down on shopping/ grocery trips, deferred a gadget purchase to that Christmas sale – all in the midst of an inflationary onslaught. While not all consumers are not behaving in the same way, and sufficient numbers are earning big dollars, yet some belt tightening is evident.

Pullback in consumer spending, higher costs, political bickering and conflict / wars are impacting corporate results. Margins are under pressure as companies face higher costs, lower margins and overall higher inflation.

Wage bills, energy and raw material costs together with overall supply chain constraints is not painting a pretty picture either. While some businesses are trying to cover rising labour costs and higher input prices, others are increasing prices to swell their profits.

Slowdown in corporate revenues / profitability and lower guidance is manifesting in layoffs, spending cuts and impending consolidation. As per Layoffs.fyi, major tech companies have announced about 100,000 layoffs this year.

Suspicions of an extended slowdown are being confirmed by industry experts. Goldman Sachs group has lowered earnings estimates for the S&P500 index for each year until 2024, saying margins contraction in the third-quarter signals more pain ahead. Inflationary years with high interest rates are lie ahead.

What Tech Corporate Results are telling us

Tech companies, which led the U.S. economy and stock market upwards, have declared poor Q3 2022 results, confirming the impact of global economic jitters, soaring inflation and rising interest rates.

Social media companies too have seen a pullback in digital advertising, smartphone and computer sales and cloud computing are showing signs of slowdown. Some shoppers have enhanced spending on travel, concerts and sports, rebuilding on experiences.

Here are key highlights from some tech company results for Q3 2022. Amazon sawnet sales increase 15% to $127.1 billion in the third quarter, compared to $110.8 billion in Q3 2021; yet this fell short of wall street expectations. Net income decreased to $2.9 billion, Operating cash flow decreased 27% to $39.7 billion, compared to $54.7 billion for the trailing twelve months ended September 30, 2021.

AWS declared revenues of $20.5 billion vs. $21.1 billion expected, accounting for all of the company’s profit, with an operating income of $5.4 billion; yet this was its slowest growth since 2014. AWS saw 200 points of margin compression. Data centers and hardware are driving up the company’s costs. Amazon expects fourth-quarter revenue between $140 billion and $148 billion, as against street expectations of over $155.15 billion.

Microsoft shares have fallen over 20% so far this year, while the S&P 500 stock index is down 19% over the same period.

It declared revenues of $50.1b, an increase of 11%, with an operating income of $21.5 billion (up 6%). Net income at $17.6 billion and was down 14%.

It also gave a guidance $52.35 billion to $53.35 billion in revenue for the fiscal second quarter, which implies 2% growth at the middle of the range (as against street expectations of revenues of $56+ billion). 

Similarly, Apple has shown revenue growth of only 2% year-on-year, closing at $83billion. iPhone sales were at $40.67 billion vs. $38.33 billion estimated and service revenue at $19.60 billion (up 12%). This sudden slowdown in tech earnings is exposing a weakness. They haven’t really found a new, very profitable idea in years. The iPhone, 15 years after it upended the industry, still drives Apple’s profits.

The computer market is fast deteriorating. “There were so many PCs purchased in the last two years that there’s no demand,” said Mikako Kitagawa, a technology analyst with Gartner, a market research firm. “Plus, hiring is frozen, so businesses don’t need new PCs.”

Industry researcher Gartner said earlier this month that PC shipments in the quarter fell 19.5% year over year, and chipmaker AMD issued lower-than-expected preliminary quarterly results tied to a weaker than expected PC market and significant inventory corrective action across the PC supply chain.

GOOGLE reported revenues of $69 billion for the quarter, up six percent versus last year.  Operating and Net income were down by around $4 billion and $5 billion, respectively. The company saw search ads rise only 4% in the third quarter, and YouTube and third-party ad networks each fell 2%. 

Google Cloud reports revenue of $6.86 billion, up from $4.99 billion in 2021. Its losses widened slightly, from $644 million to $699 million.

Sundar Pichai, CEO of Alphabet and Google, said: “We’re sharpening our focus on a clear set of product and business priorities. Product announcements we’ve made in just the past month alone have shown that very clearly, including significant improvements to both Search and Cloud, powered by AI, and new ways to monetize YouTube Shorts. We are focused on both investing responsibly for the long term and being responsive to the economic environment.”

Despite years of investment in new businesses, Google and Meta still rely mostly on ad sales, leaving them vulnerable to the disruptive upstarts that they once were. YouTube, which is owned by Google, and Meta’s Facebook and Instagram social media platforms are being challenged by the much younger TikTok.

A few days later, the chip maker Intel announced a $10 billion cost-cutting program and lowered its profit forecast for the year. “It’s just hard to see any points of good news on the horizon,” its chief executive, Patrick Gelsinger, told investors.

Demand could begin to wane for more products and services as families spend down their pandemic savings and struggle to keep up with climbing costs, especially if the job market begins to slow.

With massive layoffs being announced by tech companies, costs will come down and the market may begin to appreciate the belt tightening, as it has done after the announcement of 10,000+ layoffs by META. Improved CPI data has also cheered markets in the last few days.

Yet, the era of explosive growth and low inflation are over. Market pundits have announced the onset of an inflationary decade.

© Anu Maakan 2022

The timeless lure of IPOs

Saudi Aramco holds the record for largest IPO (Initial Public Offering) of all time. It raised $29.4b on 11^th December 2019. It is closely followed by Alibaba at $25b.

Biggest IPO of all time (Source: Statista)

IPOs are leading to enormous wealth creation, globally. It is no longer a phenomenon of the developed world. Nasdaq and Shanghai stock Exchange led the number of issues in 2020, with 272 and 220 each.

‘2020 has seen the highest IPO capital raising activity in a decade, with USD 331 billion raised across 1,591 listings – a 42% increase compared to 2019’, says Baker McKenzie.

Snowflake raised $3.36b in 2020, Zoom raised $1.5b and Kuaishou Technology, a short video platform sold 365.2 million shares at the Hong Kong stock exchange, raising $5.4 billion, amongst hundreds of others.

The Financial sector led with 360 issues and $108b in capital raised. They were followed by Technology, Industrials, Healthcare and Consumer Products. The Asia Pacific region saw immense growth, with 167 listings, up from 123 in 2019. Mainland China was the top issuing jurisdiction by volume, in 2020.

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  Global IPO 2019 v. 2020 (Source: Baker McKenzie)

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  Top Issuing Nations (Source: Baker Mckenzie)

The hunt for yield

Be it our search for new frontiers or higher yield, there is a certain timeless appeal to it all. IPOs occupy pride of place in this arena. Not only do they offer an opportunity for superior returns (alongside the risks), they also bring the excitement and sheen of the new and unknown. Companies go through a fair bit of scrutiny when they file for IPO, especially on the prestigious stock exchanges. They need to publicly disclose financials, accounting information, tax and profits amongst other details. IPOs also carry significant costs and hence only serious candidates would take this route.

$10,000 invested in Snowflake Inc. on 16^th September 2020 would be worth 2.5 times today, similarly, $10,000 invested in 10X Genomics on 12^th September 2019 would be worth $46,625.64 today, i.e. 4.6 times the original value (as of 4^th Feb 2021). Yes, there are numerous stories of loss and disappointment too. Lyft and Super League Gaming to name a few. $10,000 invested in Lyft would be worth $7190.28 today.

IPOs are a definite opportunity to uncover value from a newly listed corporation. Unlike listed companies where information sharing and regular trading has allowed for price discovery, IPOs belong to younger and/ or new to market companies which provides much higher scope for discovery of value.

No 2 investments are equal, neither are any 2 IPOs, neither are the risks & returns.  We need to be able to evaluate a good offer from a not so good offer and monitor them on an ongoing basis.

A successful IPO helps companies raise their public profile, gain exposure and access capital directly from investors. It is also an opportunity for initial founders and investor groups to cash out. Increasingly, companies are taking the route of Direct listing as well. Direct listings allow its existing shareholders and employees sell shares to new investors, instead of issuing new stock. Spotify, Palantir and Asana have all taken this route.

What to look for in an IPO?

Before we plough in our monies into IPOs, there are a number of criteria to consider. Amongst them:

• Who are the promoters of the company, what is their experience in the business and depth in management?
• Does the business have a solid foundation and a sustainable future? Are they able to leverage technology? Are they already making money?
• What’re their business prospects and financial projections? Have they broken even?
• Who are their customers, do they provide repeat business?
• Do they face any unique risks and threats, such as disruption from new technology?
• What is the valuation of the company compared to its peers? Is there room for price appreciation?

We should be able to find detailed information in the listing documents with the exchange, called the S-1 form in the US, an ‘intention to float’ or ‘AIM Schedule 1’ in the UK. Companies must also produce a Prospectus or Factsheet prior to listing. Detailed review of the finances, business plan, risks & liabilities will give us a good sense of the investment opportunity at hand.  

How to invest?

Most retail investors are able to invest in IPOs post their listing on a stock exchange. Management, employees, friends and families of the company going public may be offered the chance to buy shares at the IPO price in addition to investment banks, hedge funds and institutions.

Large account holders with the broker taking the company public, may have the rare chance at the IPO prior to listing.

Flavours for 2021

As economic recovery catches on and vaccine cover expands, companies from multiple sectors are preparing to access the capital markets with healthier financials. Technology, Lifesciences and Innovative tech such as Healthtech, Edutech, Fintech and Biotech are expected to dominate the VC and IPO markets.

Apart from the conventional IPO and direct listings, the recent popularity of SPACs (Special Purpose Acquisition Companies) is likely to continue well into 2021. ‘The strongest trend that I see is the proliferation of SPACs sponsored by reputable asset managers, family offices or known industry players’, says Steven Canner, partner Baker McKenzie.

Amongst the hundreds of planned issuances for 2021, the most prominent ones include Coinbase, UIPath and TikTok. Coinbase operates the largest cryptocurrency exchange and boasts more than 35 million investors across more than 100 countries, driven by the growth in popularity of cryptocurrencies. This business is likely to see ongoing growth with crypto-trading and digital asset issuances increasing in times to come.

UIPath provides a platform for robotic process automation (RPA), i.e. it enables automation of repeatable business tasks and processes. It is now a $10.2 billion company, with $255 million of funding from top-tier investors. Revenues are said to be on track to exceed $400 million in 2020.

Potential Downside of IPOs

There are numerous success stories of early investors in large issues such as Amazon, Netflix, Alibaba. The real winners have been long term investors, who have kept a close watch on developments.

There are also stories of investors doubling money in less than a year, but this is high risk terrain. There is need for caution when pursuing short-term opportunism. Many IPOs have seen flattening or drop in prices after a period of sharp rise, as value is unlocked and no immediate upside is visible. Take Snowflake, Square or Alibaba, all of them have seen a correction or flattening after a period of sharp growth. We need to be able to weather these downs as much as the all-time highs. Trouble begins when we start believing that the IPO graph only goes upwards and that returns continue at the same pace year-on-year.

Ongoing gains will only come from ongoing business and financial performance. IPOs like most other investments need to be monitored and their place in your portfolio will need to be re-evaluated based on your investment objectives, risk profile and investible surplus.

© Anu Maakan February 2021

https://anumaakan.wordpress.com/

(Disclosure: This article is for informational purposes only and is not investment advice of any investment strategy) 

The promise of 2021

Endings can sometimes be more pleasurable than beginnings, and we can certainly say that for 2020.

Covid-19 has claimed over 1.5m lives, infected nearly 65m people and decimated several million livelihoods. While the struggle with Covid19 is beginning to recede in some parts of the world, it is still out of control in parts of US, Asia, Europe and Africa.

An accommodative stance from governments, reduced political uncertainty, ongoing infusion of fiscal and monetary stimulus and visibility to treatments and vaccines to treat Covid19 have inspired hope. This resulting confidence has provided a boost to stock markets around the world.

On a positive note, as much as 2020 stood for loss, death, uncertainty, historic debt burdens, fiscal deficits, and damaged investor sentiment, it has also unleashed several decades worth of innovation and change, digital transformation, higher adoption of e-commerce, home entertainment and remote work. Some of these trends are likely to carry through into 2021.

Talking about 2020

(MSCI Emerging Market, ACWI and World Indices, source: MSCI)

More than $100b has flowed into global equity in November 2020. The MSCI world Index was up 13.5% in November 2020 alone, while the S&P 500 (3699.12) and Dow Jones (30218.3) touched new highs on Dec 4, 2020.

Meanwhile, holiday shoppers in the US spent $10.8 billion on Cyber Monday, setting a record for the largest US online shopping day, according to this report. Also, retail sales in China hit record highs in November, beating the US retail sales.

(S&P 500 and Dow Jones Industrial Average 1 year performance; source: trading view)

The rally reflects investors growing eagerness to buy into risky assets, encouraged by progress in the development of Covid-19 vaccines, the cheaper US dollar and overall optimism for 2021.

Gold, Other assets

Gold has outperformed the S&P 500 over the last 1 year, 3 year period and touched its all-time highs on 6^th August 2020 at $ 2067.2, breaking its previous record of 2011. This run-up has reinstated the ‘safe haven’ status of gold, as was the previous instance in 2011 where the global financial crisis drove people to invest in the yellow metal.

Gold prices are expected to strengthen further. ‘Continued quantitative easing by global central banks, a weaker trajectory for the dollar and real rates dipping further into negative territory should all underpin demand for gold’, according to Pictet Asset Management.

(US Dollar Index, source: DailyFX)

The US Dollar Index has fallen by over 10 points from April to December 2020. With the political uncertainty in the US and the severity of pandemic, investors stockpiled into the dollar seeking a safe haven…. However, as things return to normalcy, investors will seek out riskier assets. Expectations of further stimulus and ongoing low interest rates, are likely cause further dollar weakness.

A weaker US dollar can lift foreign assets, and raise the attractiveness of risk assets such as emerging market stocks, momentum stocks, even commodities like Gold and Oil which are pegged in USD. 

Lifting the veil on 2021

Better times seem to be around the corner. Yet, we don’t know everything!

Governments face an uphill task of immunising their populace, rebuilding economies, public health and pushing growth. At best, 2021 may turn out to be an year of transition and renewal; at worst, it may include destabilising surprises and unexpected curveballs.

‘Positive base effects cannot hide the long-lasting damage caused by the pandemic – our economists estimate that because of Covid-19, global GDP is permanently 4% smaller’, says Luca Paolini of Pictet Asset Management. He estimates global growth at 5.6% in 2021, while the IMF has predicted growth rates of 5.2% in 2021; with advanced economies projected to grow at 3.9% and emerging markets & developing economies at 6%.

Stock market in 2021

The more popular and widely accepted scenario building up for 2021 is that of a bullish Goldilocks market for equity markets, i.e. steady economic recovery with low inflation expectations. This would be the most favourable case for equities and could deliver broad based gains to investors. This would be based on:

Effective & timely roll out of the vaccine and other treatments would lead to steady reopening and normalisation of economic activity. However, recovery timelines are dependent on vaccine rollout speed and percentage of population covered. Large-scale immunisation are expected to start happening by mid 2021.

Decline in unemployment, stable inflation rates and monetary policy stays moderately loose. The IMF predicts inflation to remain low. ‘In line with the subdued outlook for activity, inflation is expected to remain relatively low over the forecast horizon. Inflation in the advanced economy group is projected at 1.6 percent in 2021 and broadly stabilizing thereafter at 1.9 percent. In the emerging market and developing economy group, inflation is projected at 4.7 % percent next year, and moderating thereafter to 4%, over the medium term.’

Pent-up demand. People have been putting-off purchases, while piling up on savings. They also got stimulus checks and other forms of payments. Spending is likely to catch-up as the economy continues to open up.

Further stimulus would be needed to get economies back on track. While there is poor clarity on the specifics of the US stimulus package, there are indications that bipartisan support is gathering in the Senate for a $908 billion stimulus package.

Possible challenges for 2021

The debt burden – economies face an uphill task of rebuilding their economies while avoiding further debt build-up. The IIF said global debt would break new records in the coming months, to reach $277 trillion by the end of the year. This would represent a debt-to-GDP ratio of 365%. ‘We expect a world that is more indebted, more unequal, and more local to result in below-average long-term returns across traditional asset classes’, says UBS Wealth Management.

Sticky Geo-politics – tensions between the US and China remain elevated. Expectations are that these will only amplify further, causing more uncertainty and volatility in the currency and stock markets. Not only did the outgoing Trump administration blacklist CNOOC and SMIC, they also passed legislation on Wednesday that would increase oversight of Chinese companies listed on American stock markets. The SEC has also proposed regulations that would prohibit Chinese companies from conducting initial public offerings on American stock markets. 

In case of a resurgence of the virus, slow progress or unequal access to treatment, economic activity could be lower than expected, with renewed social distancing and tighter lockdowns. Renewed bankruptcies may also compound job losses and rising debt. Some studies are already reporting issues with the vaccines.

There are also risks of increase in inflation expectations on the back of a strong recovery. This may force the Fed will be to raise rates, which could lead to a cascading debt spiral, much like the effects of the financial crisis.  This is a significant tail risk and one to watch for.

We also need to be aware of systemic risks from a hyperconnected world. We cannot rule out the possibility of future pandemics, climate change or other catastrophic risks.

Cautiously optimistic, long-term investing is still fashionable. Hold on to those well intentioned, highly researched and fundamentally strong investments, as you gear up for 2021.

© Anu Maakan December 2020

https://anumaakan.wordpress.com/