There are many things to take out of 2020; a year where records were broken multiple times, a year where it seemed we had multiple years of events crammed into one, and a year that went both very fast and/or very slow depending on your predicament.
The year started off with a bang from a market perspective, with a very strong January which saw all asset classes perform strongly off the back of successfully traversing some major risks in 2019 which included a US-China trade agreement, a Brexit agreement, and the provision of some significant central bank stimulus to re-energise what had become a faltering economic recovery.
The year was looking in good shape absent a few lingering risks like the impeachment of US President Trump, a US election at the end of the year, and a Brexit trade deal.
Those risks were put on the backburner when a little-known virus called COVID-19 shot to fame, moving from a virus that began in Wuhan China, to an epidemic and then very quickly, a pandemic. What culminated thereafter is still very raw and very fresh in everyone’s mind. The delayed information sharing and the virulence of the virus, in addition to the frequency and efficiency of air travel, made for an extraordinary combination which would see a new strain of coronavirus sweep across the world in a matter of a few weeks.
This lack of early information sharing, along with little being known about this new strain, caused world leaders to panic and invoke what they thought was the best course of action - lockdowns. The spread of the virus and the health policy response of governments caused a sudden destruction in economic growth that no one had ever seen before. Markets went into free-fall which would culminate in losses over a 4-week period that in magnitude would have previously taken more than a year to work through. Intra-day falls and volatility were like nothing we had seen before. It was the unknown that was causing widespread panic that kept feeding on itself.
With the benefit of hindsight and some key learnings from past market falls, it more than paid to keep your head. But that is usually easier said than done. Whilst equity market movements were the most noted, as is usually the case, it was the bond market that caused the most consternation as it barely functioned through the first couple of weeks of March. What most do not know is that without a functioning bond market, all other assets don’t have a price. Thankfully, and after what seemed like way too long a period, central banks and governments stepped in to stem the destruction that had been caused by the government health policy response.
Whilst February 20 was D-day for markets, March 23 would mark the start of some of the most irrational exuberance (which is always rational with the benefit of hindsight) we have seen since the Tech Wreck leading into 2000. Markets went on a tear with almost total disregard for the underlying economic conditions that were playing out. It is fair to say that the largely coordinated stimulus from both central banks and governments, the latter of which had provided little to no stimulus since the GFC, and whilst late in its delivery, was of a magnitude that made the stimulus following the GFC look like loose change.
What caught many by surprise was not just the violence in which the market rocketed higher, but also how bifurcated the market would become. That is, anything with “Growth” or “Momentum” attached to it that had little to no debt on balance sheet and/or had ready access to debt markets, and was a Covid-beneficiary, went vertical whilst anything with “Value” or “economic cyclicality” attached to it that needed access to debt markets and was a Covid-loser, fell off a cliff. This presented a market environment like no other before it.
What transpired thereafter was Covid peaks and troughs which the market largely followed to a tee; a first wave, followed by a second wave, and most recently a third wave in most parts of the world, bar a few lucky countries.
In the background, it wasn’t all about Covid, but it’s fair to say Covid became a part of everything it touched including US-China relations, Australia-China relations, a Brexit trade deal, the US election, and Covid therapeutics and vaccines. Nothing was immune (pardon the pun). It all seemed like a blur, but it all came to a head at the back end of the year when all these issues seemed to either get worse or better in the space of a 4-6-week period.
What we’ve been left with demands some specific attention, especially given its relevance regarding the outlook for 2021 and beyond. Here are the key points.
Virus / health policy response / therapeutics / vaccines - without getting into too much of the science, which is both rather technical but also rather contentious (which it shouldn’t be except for the fact that science has become politicised), Covid-19 sits somewhere closer to the common flu than it does the Spanish Flu or the bubonic plague. That’s not to downplay its significance or it’s risks, but it’s worth providing some context. That context includes that 0.02% of the world’s population has died with or from the virus; a very large proportion of those who died were in aged care or over 80 years of age or had a terminal illness or had more than two comorbidities; currently, 0.5% of people who have Covid are in a serious or critical condition.
Lockdown, as a policy response, has been shown to scientifically aid in stopping the spread of a virus but specifically so the first time around. Its usefulness thereafter is less proven given the health policy response should be refined and perfected thereafter so as to protect those most at risk. It appears we did a rather poor job, and disappointingly so, at seeking the assistance of therapeutics throughout the year as we bet the farm on vaccines and only vaccines. Both would’ve been good.
On the vaccine front, we now have three that have passed phase-3 trials, are in production, and are already being administered. That is an incredible feat in such a short period of time, helped not only by eventual information sharing, but mostly by the sheer amount of money and bodies involved in developing vaccines, which saw us start manufacturing facilities well before phase-3 trials had ended. Technology was the game changer which saw the creation of totally new vaccines which trigger the body’s immune response to target and neutralise the virus before it can spread. The only concerns remaining now are broader safety (looking good at this stage), pace of rollout and access (will depend on which country you’re in), and likely take-up (given anti-vax movement, general safety concerns, religious beliefs, vaccine apathy). Given both governments and health officials have bet the farm on vaccines, it’s incredibly important we get a large degree of distribution and take-up sooner rather than later. The longer lockdown exists as a policy response, the worse current and future generations will be for it.
Economic damage and recovery - there is no doubting how big the economic hole was and still is. The fastest and deepest recession we will possibly ever see and the closest many will have gotten to depression. But central banks and governments did what they had to do and built a metaphoric bridge to get us to the other side. Questions remain regarding the strength and length of the recovery, but what is certain is that central banks and governments remain fully committed to do whatever it takes. Whilst the amount of stimulus was important in 2020, the shape of the stimulus will be most important to economic and market outcomes in 2021.
US politics - remains in a state of flux with deep divisions across the nation and within politics. As it stands right now, Joe Biden is the President-Elect having received the minimum required 270 electoral votes from the respective state legislatures. Absent any legal challenges changing that, he will be inaugurated on 20 January as the 46th US President. Whilst important, the current focus remains on the outcome of the US Senate which we’ll know soon after January 5 where two seats in Georgia will be decided via a runoff. If at least one of those seats remain Republican, then the Republicans retain control of the Senate. If both seats swing to the Democrats, the Senate is tied at 50-50 and the Vice President (Kamala Harris) has the deciding vote. This outcome will dictate how much of Biden’s policy proposals can get through. What’s also unknown is how progressive Biden is likely to be. If he’s too progressive, he risks making the electorate even more divided. If he’s not progressive enough, he risks annoying those that got him elected. At this stage, markets would prefer a Republican controlled Senate, but it’s unclear how markets would react to a Democrat controlled Senate, at least until we know how progressive Biden is likely to be.
Central bank and government stimulus - this largely leads on from the two prior areas noted above regarding central banks and governments doing whatever it takes and the shape of that stimulus going forward. The main area of focus is on which side does more of the heavy lifting going forward. If it’s the government side (i.e., fiscal), then inflation expectations start to rise, Value beats Growth handsomely, bonds are hurt whilst real assets and commodities do well. If it’s the central bank side (i.e., monetary), then the status quo of the last few years holds, i.e., Growth beats Value, bonds do ok whilst cash does poorly, and commodities do poorly. At this stage, it’s every asset-allocators dream and nightmare.
Chinese relations - it’s fair to say Chinese relations with most countries have soured since the start of Covid. There are some obvious reasons for this. But we can’t ignore the fact that the Chinese economy will be the world’s growth engine for many years to come. The question is then, how does the rest of the world fit into this? Front and centre right now are US-China and Australia-China relations. The US’s disdain for China is clearly shared on both sides of politics. What we don’t know is what Biden’s approach will be. At this stage, it looks likely to be softer than Trump’s approach.
Closer to home, our relations with China couldn’t get much worse, absent iron ore. They have effectively gone after almost all our export industries with bully-boy tactics in order to exert pressure to get us to backdown on the global stage when it comes to our calls for a Covid inquiry, our support for the US, and our disdain for what has taken place in Hong Kong. Most of these tactics are illegal under world trade rules, but China has the power to exert maximum pain in the interim. The real concern now is the path to resolution, all of which aren’t easy or pretty.
What does this all mean…
Clearly, none of these areas are resolved and some may never be resolved. But when we weigh up each of them in terms of their probabilities and importance to markets, the outlook for 2021 all boils down to expectations that:
This means that our outlook for markets is likely positive for 2021 especially for risk assets like equities, property, infrastructure, and corporate credit, which largely comes at the detriment of cash and government bonds where returns will be very low. The economic environment starts its long- awaited recovery, supported by a vaccine rollout which hopefully removes the economically disastrous health policy response of lockdown. And most importantly, citizens of the world can get back to some degree of normalcy with hope that a return to a pre-Covid way of life is near rather than far.
Chris Lioutas, Director, Insight Investment Consultants
Chris holds the position of asset consultant for Maxim Advisors and is a current sitting member of Maxim's investment committee.
With permission of the author, this article is presented by Maxim Private Clients Pty Ltd ASFL No. 511972
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