Optimistic realism in a vaccinated recovery

A roller-coaster of a year finished on a high note for the markets, and we start 2021 with a sense of relief that one of the most difficult years many of us have ever experienced is behind us.


Global equities finished a remarkable and challenging year in an upbeat mood, with the MSCI World making gains in December and posting positive returns for 2020 as a whole. This strong performance disguised a high level of volatility throughout the year.

Markets didn’t wait for positive news, like the arrival of vaccines. It was the commitment from central banks around the world to inject serious liquidity and governments providing unprecedented fiscal support that led to the snapback from April onward.

Thanks to downward pressure on interest rates, for much of the year there was a clear trend of ‘quality-growth’ companies outperforming more economically sensitive ‘cyclicals’ and less expensive ‘value’ shares. Everything changed again in November when the first of the COVID vaccines was announced. Markets saw a rapid rotation away from the companies that managed to benefit from lockdowns, back towards the stragglers. The imminent Biden US presidency added to the move back into cyclicals as they enjoy a more reflationary environment.

Finally, a tricky year was topped off by the last-minute signing of a trade deal between the UK and the EU. This boosted the performance of most UK shares, and particularly companies with a domestic focus.

Right outcome – wrong reason

At this time last year we foresaw a year of modest returns for global equities, which did come to fruition, but not in a way any of us could have ever dreamt of.  We didn’t foresee them losing a third of their value along the way, nor did we foresee the economic contractions that in many countries were the worst since the post-World War Two recession.

Thankfully, we began the year relatively cautiously. When COVID-19 spread around the world and markets plunged in March, our bias to growth, quality and defensive factors was fortuitous. Entering 2021, investment banks are repeating their theme from a year ago favouring deep-value and deep-cyclicality. Again, we’re sceptical. We think investments that lack structural or fundamental drivers, and with investment cases relying solely on the COVID recovery, should be avoided.

That doesn’t make us pessimists. We are optimistic, for sure, and we start 2021 with a sense of relief that one of most difficult years many of us have ever experienced – professionally and, for some, personally too – is behind us. The approval of COVID vaccines has changed the risk-reward profile of equities in 2021. Markets are probability weighting mechanisms after all, and the new spread of probabilities warrants a less cautious stance. We have upgraded our outlook on more cyclical markets such as Japan and Europe accordingly, and downgraded our outlook on defensive currencies such as the dollar and the yen.

Additional stay-at-home orders and social distancing measures designed to combat notably fierce new waves of infection and hospitalisation are compounding the declining economic trends we were already observing. Economic data surprises have had a strong correlation with equities over the last 11 months, so the prospect of negative surprises poses a risk. We think it makes sense to look to increase exposure to equities again throughout 2021, given the extremely low opportunity cost of owning them.  However, we must acknowledge this somewhat elevated risk of a market correction.

Brexit and the UK valuation gap

The Brexit deal is good news for UK assets. It shows the two sides can work together and it removes the threat of Brexit jeopardising the UK’s prospects for recovery from COVID. Business spending in the UK has lagged the recovery seen elsewhere in the developed economies by a large margin, and with new COVID restrictions further constraining the UK’s consumer services, it needs all other parts of the economy to be growing as quickly as they can.

Unfortunately, there is a long list of reasons why the UK may lag other major economies. Brexit only added to it. The UK has suffered the fourth-worst health outcome (behind only Belgium, Spain and Italy), and its economy is also more sensitive to COVID-related restrictions because of its larger consumer services sector. Our private sector is also more indebted than that of many other countries, which increases fragility and limits the capacity of firms to bounce back in a vaccinated world.

We think the valuation gap between UK and overseas equities could remain wide for the time being. The historical attractiveness of the UK’s high – and high-quality – dividend yield is more questionable today. And its outsized exposure to financial companies and oil and gas, whose profits have been held back by bigger structural forces for the last decade, could also limit any narrowing of this gap.

A more sustainable outlook

We are pleased to see that, far from derailing progress, the COVID crisis seems to have been a catalyst for a more sustainable approach to future growth among businesses, investors and policymakers. As we set out in our 2019 report Responsible capitalism, we see environmental, social and governance (ESG) factors as increasingly important in our management of investments for long-term returns. We firmly believe that having an additional ESG lens can help us improve risk-adjusted returns. Over the coming year, we’ll be building on our work to embed this extra layer of analysis into our day-to-day portfolio management.

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