Markets Weekly podcast - 04 January 2021

Henk Potts (HP): Hello it’s Monday the 4th of January 2021 and welcome to the Barclays Private Bank Markets Weekly podcast, the recording that will guide you through the turmoil of the global economy and financial markets.

My name is Henk Potts, Market Strategist with Barclays Private Bank, and each week I'll be joined by guests to discuss both risks and opportunities for investors.

This recording will last around 15 minutes and will be broken down into three component parts.

Firstly, I’ll analyse the events that moved the markets and grabbed the headlines over the course of the past year and discuss the impact of the recent Brexit and US stimulus deals, as well as offering some forecasts for 2021.

I’ll then move onto our focus section. This week I'm pleased to say our special guest is Gerald Moser, he's Chief Market Strategist with Barclays Private Bank.

We will discuss how investors should be positioned for the year ahead. Finally, I'll conclude by previewing the major events and data releases that are likely to shape the week ahead.

Let's start by reflecting on 2020 and how it sets the stage for 2021.

Despite expectations of a steady year of growth 2020, as we know proved to be a tumultuous one, in fact it was the most disruptive year to the global economy and society since the Second World War.

The locking down of economies resulted in a record drop in activity, surging unemployment, permanent losses in output, temporarily slower potential growth.

If you look at the OECD (Organisation for Economic Co-operation and Development) estimates they say that damage to the world's major economies was four times greater than the 2009 financial crisis.

The controlled lifting of restrictions did help to alleviate some of the economic pressure; a number of economies registered a robust rebound in activity through the course of the summer.

However, as we've seen over the course of the past few weeks, activity remains vulnerable to future infection surges which have triggered the requirement for additional restrictions.

As a result of the disruption we estimate the global economy shrank by 3.6% during the course of last year, that's the deepest contraction since the Great Depression.

In terms of market performance, well for investors 2020 was a reminder of the resilience of financial markets and highlighted the importance of diversification as well as being and staying invested.

Despite the disturbing economic backdrop, global equities closed the year near record highs on expectations a vaccine will arrest the virus, an ultra-accommodative fiscal monetary policy will boost economic growth, and in turn drive corporate profitability growth.

In terms of equity performance, MSCI world index of global stocks was up 14%. The S&P 500 was up 16%, in fact outperforming its 10-year average of 11.8%. Lockdown as we know lead to faster technology adoption rates.

The NASDAQ was up 44% to record its best performance since 2009. If you look at the S&P 500 sector winners and losers well it was technology, it was consumer discretionary and it was communication services that very much led the way, while energy, real estate and financials underperformed.

In Europe the STOXX 600 was down 3.9%, although we should recognise it was up 11% in the fourth quarter and 49% above its low on March 16^th. The FTSE100 posted its worst annual performance since the global financial crisis.

The FTSE100 generated a loss of 14%, you have to say that's probably less to do with Brexit and more to do with the makeup of the index and the prominence of banks, oils and miners.

The real winner was actually the Nigerian Stock Exchange which was up 45.7%, the most among 93 indexes tracked by Bloomberg.

If we look at government bond yields they were pushed ever lower as central banks slashed interest rates and injected unprecedented amounts of liquidity into the financial system.

10-year Treasury yield finished the year at 0.91%, that compared to near 2% before the pandemic.

Gold had its best year in a decade, it was up 24%, supported by lower real rates, currency debasement, and future inflation fears, along with the weaker US dollar. Dollar index down nearly 6% in 2020, trading close to a two-year low which of course makes gold cheaper for other currency holders.

If you look at oil, well crude demand was estimated to have crashed by 30% at the height of the pandemic. Demand as we know has been recovering over the course of the past few months and OPEC+ (Organization of the Petroleum Exporting Countries) extended production cuts. Brent still fell 23% since January.

In terms of the headline grabbers, the big winner, well Bitcoin, surged 50% in December, was up 300% for the year. The cryptocurrency was touted as the next gold.

I think as we look forward to this year, economic growth will be determined by the winner of the battle between the coronavirus and the vaccine.

The big question is can policymakers continue to stabilise the economic backdrop, as we take that journey from the current destruction of the pandemic to the brighter herd immunity destination.

In terms of 2021 we think the vaccine will create herd immunity by the third quarter in Europe and the United States allowing growth to accelerate, overwhelming monetary policy support will be maintained to ensure the recovery and sustainability of debt, emergency fiscal measures will eventually taper off as we go through the course of this year.

We think growth in advanced economies will underperform emerging economies as China and India bounces back. Manufacturing we think will lead the recovery, while the intensification of lockdown measures will continue to weigh on services in the first half of the year.

We think inflation will remain subdued and unemployment rates will be significantly above pre-pandemic levels at year end. For the global economy a year of recovery as I say, we're anticipating global growth of 5.6%.

The US fiscal stimulus package was finally signed into law by President Trump. The 5,000 page $900bn relief bill includes a second round of direct stimulus payments to households, funds to support small businesses, schools and health providers, help for the unemployed, along with individuals facing eviction and food insecurity.

Broadband infrastructure development was also a key element of the bill. Individuals will get $600 direct payment, that's for people making less than $75,000, there will also be $600 for each of their children.

We should remember that’s around about half the amount individuals received from April’s CARES Act. Democrats and President Trump have been pushing for a much higher level, something closer to $2000.

Small business aid: the package includes a $284bn extension to the paycheck protection programme.

If you look at the impact well the surge in coronavirus as we know has been hitting activity. The stimulus aim is to boost activity through increasing income and consumption in the first quarter thereby providing a bridge to the vaccine.

We expect the US economy to flat line in Q1 then gain momentum as the year goes on.

Of course Brexit was at the heart of many investors thoughts at the end of last year. A last minute compromise on fishing and level playing field governance paved the way for the UK and EU to successfully conclude a trade agreement.

The five-year review clause offers an opportunity to develop and broaden the agreement.

The deal guarantees tariff free trade on most goods and creates a platform for future cooperation on issues such as crime fighting, energy, and data sharing.

The trade agreement thus avoids the scenario of the EU/UK falling back to the tariffs and quotas that would come into play under a basic WTO (World Trade Organisation) rules.

Such a no deal scenario was widely feared by businesses for seriously disrupting trade, potentially creating chaos at the borders, and possibly even resulting in shortage of essential goods and soaring prices.

However, the UK will still leave the European single market and the customs union, implying not only a hard customs and regulatory border where as we know goods will face checks and controls, but also exit from the single market for services which account for around 80% of the UK economy.

Even with a trade agreement this Brexit is one of the hardest possible outcomes for the UK, and will result in deep adjustments for many businesses and of course supply chains.

That's where we were of course during 2020. At this point I'll bring in Gerald to consider how investors should be positioned for this year. Gerald, good to have you with us today.

Gerald Moser (GM): Hi Henk, it's good to be with you again.

HP: Let's start with the basics shall we, what is the preferred asset class for 2021?

GM: Well the straight answer is equities.

You've just painted a picture of a recovery in the economy thanks to the vaccine, thanks to the central banks and also the government action, so I think if you are in a risk-on environment you probably still prefer to be in equities compared to other asset classes.

Now it's true there's a lot of discussion around the valuation of equity markets. At face value absolute levels, we are pretty much as expensive as it's ever been, probably just shy of the top of the tech bubble in 1999/2000.

But if you think about it, it's not only equities that are expensive it's pretty much any asset class and this is because of the central banks that have been pumping liquidity into financial markets.

Back during the tech bubble, again in 2000/2001 you had the choice to buy equities, let's use for example the S&P 500, that was trading at 22 times forward earnings, which is around where we are right now, but the alternative at the time was to buy the US 10-year Treasury yielding 5%.

So you had the choice going into a pretty risky asset like equities that were at record valuation at the time or to have a very safe investment still returning you 5%.

Now, right now the alternative to investing in US equities at 22 times earnings, forward earnings, is basically a US 10 year which is below 1% and with central banks being adamant they want to keep rates low for a very long time, with the Fed basically forecasting that they won't move rates before 2023, and also they are very much, they want to keep the long end of the curve pinned down.

So, I think really you don't have much alternative than to be in equities and especially with the recovery coming through, with earnings growth potentially around 20-25%, I think it still makes sense to be in equity markets.

HP: Okay so within that framework where do you see the best opportunities for investors?

GM: I think that's a very good question, because when we talk about equity markets and I've just mentioned indices here, because of the valuation I think at the index level the return is going to be lower than what it was for example on an annual basis over the past 5/ 10 years.

I think, to invest in equities you have to be much more selective, you have to look for companies that have the right kind of exposure and I think that means broadly speaking first thinking in terms of style you probably want to look for quality companies.

As I said, one of the key risks for equity markets in 2021 is if investors start to price rates moving higher faster than expected, you know a bit akin to the taper tantrum in 2013 when the rate market moved very quickly to price some increase and that clearly spooked the equity market.

I think you can only justify the current valuation if you think that interest rates are going to stay low. So I think it's important to buy quality companies with strong balance sheets that wouldn't be suffering so much in case you see an event like this one when the markets start to price rate or yields moving higher.

So I think quality companies, strong balance sheets, ability to generate free cash flow, I think this is very important. We don't really want to go into very deep cyclical or very deep value, I think it's really being selective there.

Another way to think about it is to think about the long term and here you can identify themes that we think will continue to do well over the next few years. If you think about it, this crisis has been a catalyst for digitalisation.

Everyone knew that before you needed an online presence but I think this has been boosted even more during the pandemic and it will continue to be with us.

So I think investing in companies exposed to higher digitalisation, cyber security, software investment, this is an area where companies will continue to invest heavily and I think the growth will be there.

Another thing that that is happening, whatever we think, is the demographic shifts. In the western world, people are getting older and older.

In the emerging market space, you see a middle class emerging quite strongly in China, probably further down the line in India and this is a very large market and if you have the companies that are exposed to those markets I think they would continue to grow quite strongly over the next few years.

And then I think climate change, of course, continues to be a very important thematic. It is part of the government spending in Europe, probably in the US, and I think getting the exposure to all the climate change related investment opportunities will also provide investors with good returns.

HP: Thank you for highlighting those opportunities. Finally, I want to get your views on alternatives as an asset class. Where should exposure to alternatives fit with investors’ portfolios?

GM: I think this is a very relevant question. As I said before valuations are stretched in equities and fixed income.

Over the last few years a typical 60/40 portfolio, that is investing 60% in equities and 40% in fixed income, which was seen as a good mix that would provide you with upside when the market is going up but also some hedges when the market is falling because of the fixed income part, has done extremely well.

But I think considering where rates are right now it's very difficult to see rates moving much lower from those levels and at the same time, as I said before, on the 10-year Treasury, you just earn a yield that is below one percent, you are not even compensating for inflation, so in real terms you are in negative territory.

So I think considering alternative as a key part of a portfolio is very relevant at the time being, it’s very relevant currently. When you think about alternatives, you mentioned gold had a stellar year in 2020 but we still think it makes sense to have it in 2021.

The reason why it did well in 2020 is because of all the financial related demand i.e. ETF having to buy physical gold to back up the investment, but I think as the recovery gets stronger and stronger you will see also jewellery demand resuming and that I think will be a very good supportive element for gold.

You might also see central banks moving away from the dollar and continue to buy more gold. So I think there might be more demand coming for gold in 2021 and at the same time as I said real yields are negative this is usually the biggest hurdle to invest in gold because it's a non-yielding asset so this is really not a problem and we think it will continue to be supportive for gold.

Then I think private markets, you see more and more companies that stay private for longer and they only go to the public market when they are at a much mature stage of their development.

So I think you will continue to see good opportunities in private market and also the thematic I mentioned before, some of them are at an early stage and to get that kind of exposure to an early stage you really have to go into the private market.

So this is something that I think makes a lot of sense if you want to invest for growth in the long term.

And then I think finally hedge funds. This is an asset class that has a bad rap because of the performance over the last few years, but again with now every asset class expected return probably lower over the next few years and also volatility higher than what it was over the last few years, I think hedge funds will be an interesting proposition again especially if you look at the part of the hedge fund industries that is non correlated to equity market.

Market neutral, merger arbitrage, I think those are strategies that will enhance a portfolio by providing diversification.

HP: Well thank you Gerald for your insights today. We will of course continue to update this as the global economy and investment universe evolves throughout the year. This week the focus will be on the Georgia Senate race and the US employment report.

Georgia Senate run-off election will take place on Tuesday. This is after candidates failed to achieve the required 50% majority in the November election.

The result will determine the balance of power in the Senate and will directly impact President Biden’s ability to implement his domestic agenda, cabinet appointments, and Supreme Court nominations.

To remind you, Republicans have controlled the Senate since 2014. Republicans currently have 50 of the 100 seats. If Democrats were to take the remaining two seats it would be a tie and the Democratic Vice President Kamala Harris would have the casting vote.

Who's going to win? A Democrat has not won a Senate seat in Georgia since 2000, but Biden won the state for the Democrats in November for the first time in almost 30 years.

Polling data suggests both seats are very tight with the election hangover a difficult element to factor in. We may not of course know the winner on election night.

Moving on to the US employment report. We know that US economic momentum has slowed in recent weeks as tighter restrictions impacted activity.

Initial claims rose during the course of December. In terms of expectations, we think that payrolls will decline by 50,000, bringing an end to seven consecutive months of employment gains that have totalled 12.3m.

We look for the unemployment rate to rise by 0.1% to 6.8%, average hourly income to increase by 0.2% month on month, 4.5% year on year.

And with that I'd like to thank you once again for joining us. We hope that you found this podcast interesting, informative, and it's given you a guide as to how investors should be positioned for 2021.

We will be back next week with our next instalment but for now may I wish you every success for the trading week ahead.