Investment management consultant MATTHEW FEARGRIEVE shares his views on what 2021 holds in store for the stocks, shares and bonds in your personal investment portfolio.
Global Equities
The Biden victory in the US presidential election in November restored a high degree of optimism and buoyancy to global stock markets, in particular the S&P500 and the FTSE100. A second big boost for global stocks is the emergence of vaccines in November, with the UK leading the way.
US equities
The Republicans have retained control of the Senate, which allayed the market's fears over Biden's desire to regulate Big Tech and adopt a values-based approach to financial regulation. Capitalism is a coward, and many market commentators welcome political and legislative inhibitors on Biden's ability to make changes to certain industry sectors and financial systems.
Our view is the Biden presidency most likely signifies a continuation of the status quo for Big Tech, oil an gas. Clear winners under Biden will be pharma and healthcare as he seeks to get control of the coronavirus and reinstate Obamacare.
The position in the Senate also suggests that the Fed's support of UK markets, that provided a huge psychological boost for US stocks in Q2, will continue.
You can read more about the impact of Biden on your investments in our blog here.
Our 2021 outlook on US equities is Positive.
UK equities
UK indices, which have been significantly trailing the S&P500 this year, can be expected to rally on news that the UK has been the first country to approve a covid vaccine.
Many large-cap UK companies are still trading at significant discounts to their value, with covid resurgence and Brexit worries priced in. Retail investors withdrew £2.7bn from investment funds invested in UK stocks in Q3, with asset allocators placing a sizeable discount on London listed companies. This has left UK investments looking decidedly cheap. With the Brexit process due to be completed by 31 December, thereby restoring some certainty to the UK stock market, many FTSE100 stocks will not be cheaply priced for much longer. For more information on UK buying opportunities, see our blog here.
Our 2021 outlook on UK equities is Neutral-to-Positive.
European equities
The European Central Bank (ECB) provided welcome support for the Eurozone economy, together with a recovery fund to channel resources to the hardest-hit parts of the European economy.
In addition, European stock markets, unlike those in the US, do not suffer from a glut of large- and mid- cap technology companies that look somewhat overvalued and combine to maintain the index at what many on Wall Street consider to be a precariously and unsustainably high level.
That said, the resurgence of covid across Europe and uncertainties about the degree to which fiscal stimulus will be provided by the European Central Bank, combined with the UK's departure from the bloc and the current absence of a centrally-approved vaccine in the EU, have caused European indices to lag behind the S&P500. Recent news on the efficacy of vaccines being developed in Europe are cause for confidence, however.
You can read more of our views on European equities in our blog here.
Our 2021 outlook on European equities is Neutral-to-Positive.
Government Bonds
The pandemic has dealt a major blow to yields on government bonds and gilts, with yields so low as to be negligible in many cases.
Q3 saw a low volatility environment compared to previous years, as sentiment around the macro backdrop and the covid recovery improved. Ongoing growth in central bank balance sheets proved a boon for risky assets. There is a view that developed government bond markets are on a path to “Japanification”, with economic data having little impact on prices and a larger share of the market owned by domestic commercial banks, a trend that is becoming particularly evident in the US. We think that yields are therefore likely to stay within the tight ranges that were in play over Q1 and Q2, with any yield increases likely to be short-lived.
Current government spending is unlikely to be enough to carry economies till the “end” of covid, and this is particularly the case in Europe, where the room and willingness to manoeuvre appears less than in the US or the UK.
US government bonds
US government bonds are beginning to look interesting again, with the recent rise in yields offering some protection if US economic growth disappoints over 2021. Yields on U.S. government bonds had stalled near all-time lows. The yield on the benchmark 10-year Treasury note ended Q3 at 0.69 % from 1.88% at the beginning of the year. The 2-year note yield tumbled to around 0.13% at quarter-end. We have a fairly favorable outlook for investment-grade corporate bonds, and we are also finding opportunities in high-quality securitized assets, including AAA-rated asset-backed securities.
Our 2021 outlook on US Treasuries is Neutral.
UK government bonds
The return on UK gilts is on the floor. Comparative to US Treasuries and EU government bonds, there is disappointingly little value in UK government debt given their poor relative returns compared to other developed markets.
Unemployment is expected to rise in the UK in 2021 as the fiscal packages to support workers are curtailed, which in turn will place downward pressure on wage inflation. Whether that is enough to reduce CPI levels or at least not allow them to increase too much more is yet to be seen.
Our 2021 outlook on UK government bonds is Negative.
European government bonds
Eurozone government bond yields hover near record lows thanks to the ECB fiscal stimulus, and investors have to look elsewhere for income.
Aside from the G8 European issuers, peripheral euro zone sovereign debt yields nudged higher over November as new lockdown measures in Europe increased the demand for safer assets. Yields had dipped previously when the European Central Bank gave a clear signal that it will provide more quantitative easing in the eurozone in December.
Most of the Eurozone represents an expensive market, and the strong Euro makes EU government and ECB debt expensive.
We think that European rates will remain pinned down by both central bank intervention, and by flight to quality flow, with 10-year Bund yields heading lower to -0.70%.
Current government spending is unlikely to be enough to carry economies till the “end” of covid, and this is particularly the case in Europe, where the room and willingness to manoeuvre appears less than in the US or the UK.
Our 2021 outlook for Eurozone government bonds is Negative.
Corporate Bonds
Whilst the coronavirus dealt a major blow to yields on government bonds and gilts, it is a different story for corporate bonds, however, with the spread (ie., the difference between corporate bond yields and those of government bonds) falling back to pre- COVID levels.
Many investors and fund managers are of the view that credit is the place to be, with attractive coupons (ie., the interest rate paid on the bond's face value by its issuer) being offered by companies desperate to shore up their balance sheets in preparedness for the covid uncertainties of 2021.
Bonds issued by companies with healthy balance sheets and cash reserves have provided investors with a good hedge against a Second Wave. And corporate bonds are particularly attractive in low- interest rate environments, in which the incidence of issuer default is typically low.
The extraordinarily low yield environment encouraged corporations to issue new bonds, retiring debt with higher interest rates.
We think that the boost to economic growth from fiscal and monetary stimulus earlier in 2020 is likely to sustain the market’s recovery into Q4. A delay in additional stimulus, high unemployment and the continued economic impact of the virus will potentially weigh on economic growth in 2021.
The market for US investment grade bonds and junk (high-yield) bonds continued to recover as spreads, or the risk premiums over Treasuries, narrowed during Q3.
US investment grade
US economic fundamentals are weak, but the Federal Reserve (Fed) is expected to remain supportive by extending its purchasing scheme and signalling a shift for setting its monetary policy, allowing for a rate environment that will likely be "lower for longer".
Democrats and Republicans have been at an impasse over the next virus relief bill. Our view is the economy and risky assets would struggle in the absence of a new round of stimulus. Against this backdrop, the Fed expects the economy to contract by 3.7% this year, before bouncing by 4% in 2021.
We have a fairly favourable outlook for US investment-grade corporate bonds, and there may also be some opportunities in high-quality securitized assets, including AAA-rated asset-backed securities.
Our 2021 outlook for US investment grade bonds is Neutral-to-Positive.
US junk
We think that US high yield bonds are less attractive than their European counterparts. In mid-October investors flocked to US junk bonds on vaccine hopes bolstering riskier corporate borrowers, but borrower defaults over Q2 and Q3 are worrying.
The 2021 outlook for the US junk bond market depends on the extent of dividend recovery. The future for dividend payments based on historical data does not look bright, with the bear market of dividends lasting much longer than their total return (growth and income) counterparts, on average lasting 4.8 years compared to 1.5 years.
A relaxation of lockdown rules in the US 2021 would lead to substantial recovery of the economy and result in dividends returning, but we think that the US economy is unlikely to return to anything like ‘business as usual’ for some time, particularly if covid does not dampen down, and Biden gets tough both with the virus and with those States that were resistant to imposing lockdowns in 2020.
Our 2021 outlook for US high yield bonds is Neutral.
European investment grade
Economic fundamentals in Europe (including the UK) are weak, but demand for investment grade corporate bond issues by European issuers is robust due to the ECB increasing its purchases back to levels seen in March and June this year. And with many large European companies having built up war chests over 2020, we may expect them to remain fairly safe issuers in 2021.
Our 2021 outlook for European investment grade bonds is Neutral to Positive.
European junk
Investors piled into bonds issued by some European companies vulnerable to the pandemic last week, even as a Second Wave of covid was threatening to bring the summer economic rebound grinding to a halt, largely because corporate default rates in Europe and the UK are projected to be lower than thought at the start of the pandemic.
We prefer European high yield bonds to US high yield bonds because of the ongoing fiscal support that the ECB has indicated will continue to be made available in 2021 in the form of the pandemic emergency purchase programme (PEPP).
There are, however, covid inhibitors on optimise for European and UK high-yield debt. If the consensus assumption, that a second hard lockdown of the economy can be avoided, proves wrong, this would clearly introduce some substantial setback potential for risker corporate debt issuers.
Our 2021 outlook for European high yield bonds is Neutral to Positive.
You can read more of our views on European corporate bonds in our blog here and our Q3 UK and US investment outlook here.
Matthew Feargrieve is an investment management consultant. You can read his business blog here, and see his Twitter feed here.
Important information: the views expressed in this article are opinion only, and are not intended to be relied upon as financial advice or treated as a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to an authorised financial adviser.