It has been known for some time that finance was detached from the economy, but by now news and transactions are so fast that they have managed to get the most important indices to record highs, it is a pity that the American and world economy will take longer to to recover. So we expect a good period of investors who will want to sell to cash in on the gains and the indices will go down, at least for some time.
Vaccines are still struggling to be distributed and until the end of Q3 it will be difficult to see the balance sheets of large non-tech companies return to pre-covid levels.
There are those who also talk about inflation, indeed many take it for sure, so we have published a quick vademecum on how to invest with inflation , trader never know.
In Italy , the minister of the economy (who this time seems to be a serious and prepared person) says that from the 2nd quarter of 2021 Italy’s GDP should return to growth, even more in the 3rd and 4th quarter. If everything goes smoothly from May onwards, the lockdowns should be just a bad memory, due to limited epidemics, this will allow the catering, hotel and tourism sectors in general to recover slowly and return at full speed around July / August , even if the masks in closed and public places will be mandatory at least until the end of 2021.
In 2022, the economy is expected to return to normal
The following are the forecasts after the coronavirus pandemic event which will be a historical event and which will mark the financial , economic and political events from 2020 until 2022, if all goes well.
2020 was a year of surprises. There was the speed with which the pandemic escalated, the severity of the blockades, the extent of the government’s stimulus measures globally, and the extent of the stock market rebounds. Perhaps the biggest surprise is that global equities have gained about 12% since the start of the year at the end of November, something few would have predicted during a global pandemic. With the US elections behind us and effective vaccines on the way, investors have turned optimistic, pushing the S&P 500® index to record highs.
Likewise, we have a positive medium-term outlook for economies and corporate earnings. We are in the first recovery phase of the post-recession cycle. This implies a prolonged period of low inflation, low interest rate growth that favors equities over bonds. However, there are some short-term risks. Investor sentiment turned overly optimistic following the vaccine announcements, markets vulnerable to negative news. This could include renewed lockdowns in Europe and North America as virus cases escalate, logistical difficulties in vaccine distribution, and negative economic growth in early 2021 if government support measures are canceled too quickly. Geopolitics could also provide negative surprises from China , Iran or Russia as the new Biden administration takes power in the United States.
Our cycle, value and sentiment (CVS) investment decision making evaluates global stocks as expensive (with the very expensive US market offsetting better value elsewhere), sentiment as overbought, and the cycle as favorable. This leaves us slightly cautious on the short term outlook, but moderately positive for the medium term with expensive valuations offset by the positive cycle outlook.
Overall, we see the following implications for various assets in 2021:
• Equities should outperform bonds .
• Long-term bond yields are expected to rise, albeit with steeper yield curves likely limited by continued low inflation and central banks on hold.
• The US dollar is likely to weaken given its countercyclical nature.
• Non – US equities will outperform given their more cyclical nature and relative valuation advantage over US equities.
• The value equity factor to outperform the growth factor.
A return to normal by the second half of the year should help extend the rotation that began in early November from technology / growth leadership towards cyclical / value stocks. During the COVID-19 pandemic, tech and growth stocks enjoyed favorable winds from an earnings boost and lower discount rates. These favorable winds are expected to turn into headwinds once a vaccine is available and the blockages have been loosened. This should allow the normal recovery dynamics of the first cycle to resume, with investors pivoting towards relatively lower-value, non-US stocks benefiting from the return to more normal economic activity.
Post-COVID vulnerability
Major economies escaped the pandemic and blockades with relatively little long-term economic damage thanks to substantial monetary and fiscal support. Wage subsidies and job retention programs have prevented a significant increase in unemployment rates in most countries. In the United States, corporate bankruptcies and consumer loan default rates were lower in the September quarter than in the same period in 2019. The hospitality, tourism, transportation and retail sectors were hit hard. but the overall damage to the balance sheet of businesses and households was relatively limited despite the large blocs.
The most notable damage of the pandemic is the increase in public debt. The International Monetary Fund (IMF) predicts that the gross public debt of the G7 economies 1 will increase by 23% of gross domestic product (GDP) in 2020. High debt makes public finances vulnerable to rising interest rates. This is unlikely to be a significant problem in the next couple of years, but it will matter when spare capacity is finally exhausted and inflation starts to rise.
It is speculated that governments will soon begin reducing deficits through tax increases and lower spending, slowing the recovery. This seems unlikely anytime soon. The two graphs below show that, despite rising debt levels, net interest expenses are expected to trend down for all major economies. By 2023, the Japanese government’s net interest payments are expected to be close to zero, despite gross debt exceeding 250% of GDP. Two-thirds of Japan’s public debt has a negative yield.
Governments will come under pressure to reduce deficits only after bond yields rise significantly and markets question debt sustainability. We expect fiscal austerity and tighter monetary policy to be a few years away.
Bond yields and stock rotations
Government bond yields will rise
Long-term government bond yields are likelyface upward pressure from a vaccine-led recovery in 2021. Central banks accommodative and no inflationary pressures in most countries as output gaps remain large should limit yield increases. Major central banks have made it clear that they will wait until after inflation rises before raising rates. This was evidenced by the recent move by the US Federal Reserve (the Fed) to target average inflation and allow it to exceed its 2% target. A slow-reacting Fed should limit the 10-year Treasury yield rise to between 1.1 and 1.4% from the current 0.85%. It is reasonable to expect similar increases of between 25 and 50 basis points in German bund and British gilts yields. Japanese government bond yields,
The stock market rotations continue
The announcement of a successful COVID-19 vaccine in early November led to timid signs of a market rotation from high-tech growth stocks to more cyclical value stocks. Tech stocks have received two benefits from the blocks. The first was the increase in earnings from tech stocks when consumers worked from home, spent online, and shopped for technology. The second was from the decline in government bond yields. Tech stocks are considered to be long-term as they are expected to increase their earnings over the long term. Falling bond yields made the present value of those future earnings more valuable.
The rotation from tech stocks is likely to continue into 2021. The earnings momentum of tech stocks from the blocks has peaked and there may be a drop in demand in the coming quarters as the pandemic has pushed forward some of the tech spending. Higher bond yields will also be a barrier to technology stocks. Conversely, the global recovery and higher bond yields should help enhance cyclical stocks. Financial stocks are heavily weighted in value indices and we expect they will benefit from higher margins as yield curves are reversed and stronger revenues as credit growth improves. At the end of 2020, banks, globally, are trading at a large discount on the broader market.
Post-vaccine recovery prospects should also help non-U.S. Markets outperform the U.S. The S&P 500 is overweight the tech and healthcare stocks that dominate the growth factor, while the rest of the world has more financial and cyclical stocks than make up the value factor. Investors are likely to prefer the relatively lower value and non-US stocks which will benefit from the return to more normal economic activity.
Risks: blockages, vaccine delays and too much optimism
Vaccine announcements and overcoming electoral uncertainty in the United States removed two of the short-term points of concern about the outlook. The main risk now is the amount of investor optimism following the vaccine announcements. Our composite contrarian sentiment indicator is not yet on the overbought threshold in early December, but it is getting closer. Investors are positioned for bullish gains, which makes markets vulnerable to disappointing news. This could result from the current increase in virus cases and a potential drop in demand in early 2021 as government support programs expire and are not renewed. In particular:
• Infection rates are rising in the United States. Schools have been closed in New York and there is a growing risk of more widespread lockdowns.
• Although infection rates are decreasing in Europe following the recent blockades, there is a risk of a new spike in infections in early 2021 as blockages are reduced.
• It seems likely that Republicans will retain control of the US Senate in 2021, making an additional fiscal stimulus package subject to difficult negotiations with Democrats in the incoming Biden administration. A stimulus package could be small and delayed until the end of the first quarter, creating the risk of negative GDP growth in the first quarter of 2021.
The other risk to equity markets in 2021 is rising bond yields. Equity markets can often navigate rising bond yields if the reason is better economic growth prospects, but a rise above 50 basis points can provide a test. Tech stocks received a strong valuation boost from lower discount rates. The big tech stocks make up about 25% of the S&P 500’s capitalization. They accounted for nearly all of the gains in the overall market for 2020 through November. A bond-led reversal in tech stocks could stall the overall market even if the remaining 75% of the S&P 500 makes post-pandemic gains.