See the light
Stock markets reached record highs before the Thanksgiving holiday. A brighter economic future, the promise of widespread vaccinations and the choice of well-respected individuals for a Biden cabinet have all contributed to strong market returns. Earnings forecasts are being revised up and volatility is falling. I have always been amused by the advice to never forecast anything, let alone the future. Experience suggests taking heed of that. However, today I feel pretty confident that portfolios should be positioned for continued good performance from equity markets as we head into 2021.
Some things just drag on, don’t they? I’m thinking in particular about the reluctance of Donald Trump to concede the US election to Joe Biden, the fact that the coronavirus pandemic will extend well into 2021 – even with a vaccine – and Brexit. The British people voted in the EU referendum 4 months before the Americans voted for Trump in 2016. They were promised a new deal with Europe and more control over trade, borders and finances. Well a deal has not been reached at the time of writing. One might be struck over the coming days but the headlines on Friday morning were not encouraging. I wrongly argued back in 2016 that the Brits would never vote to leave Europe and Trump would never beat Hillary Clinton. I wish I had not been so spectacularly wrong!
Up and away
Still, there is no room for dwelling on past wrong shouts. Looking forward it won’t be too long before there is a new President in the US and a new arrangement between the European Union and the United Kingdom. There should also be an end in sight to the pandemic. Sentiment will be volatile but there is a brighter – or at least more certain – future ahead. This is why equity indices rose to new all-time highs this last week. There are also signs that analysts are starting to revise up their earnings forecasts for the coming year. For the S&P500 the number of upward revisions to 12-month forecasts of earnings per share have jumped in November. Indeed, for the period since August there have been a third more upward revisions to estimates then there were downward forecast revisions in the first 4 months of 2020.
The announcement of Janet Yellen as proposed US Treasury Secretary was also taken well by markets. There are few people with better economics and public policy credentials than her. She is seen as a dove but note that she was the Federal Reserve Chairman when interest rates started to increase and presided over 5 hikes in the Fed Funds rate between 2015 and the end of her term in office in February 2018. More recently she has been vocal about the need for fiscal policy to take a leading role in economic recovery relative to monetary policy. My recollection is that Yellen was treated respectfully in appearances before Congress when she was at the Fed and her ability to back policy decisions with well thought out economic arguments should bode well for getting fiscal plans supported, even if Congress remains split. Few individuals have been both Fed chair and Treasury secretary – a testimony to the recognition of Yellen’s intellectual stature. I am sure she will also work well with the current Fed Chairman (her successor), Jerome Powell. Investors should take heart that there will be some serious policy making in the years ahead.
No austerity in 2021
In my conversations with investors there does seem to be general agreement that the economic outlook for the next couple of years is encouraging. There is the potential for a huge amount of pent-up demand to be realised supported by the need to re-stock inventories in the business sector and by targeted fiscal spending. Of course there are concerns that, at some point, governments will need to row back on fiscal stimulus but, in my view, concerns about an imminent return to austerity are wide of the mark. Even in the UK, where Chancellor Sunak outlined the government’s spending plans this week, the cuts to spending were limited and there were promises of even more fiscal help as long as the economy needs it. Putting the fiscal house in order is for another day. And why not? Governments can borrow at nearly zero interest rates and central banks are still buying lots of government bonds to help keep those rates low. I hosted a webinar this week with Jean-Claude Juncker, former President of the European Commission, to discuss the outlook for Europe in a post-COVID-19 world. He stressed the need to get borrowing down and restrict further big increases in government debt levels. However, he also made the point that it was the right thing to do to suspend the Maastricht criteria and getting debt under control could wait. Fiscal retrenchment is not for 2021.
Bias to equities
The base case for the outlook should be that inflation remains low and central banks have a quiet year. There could be some curve steepening but the demand for long-dated, high quality assets may limit that. On the basis of where equity markets are today, the yield advantage for stocks will remain substantial. Taking current consensus forecasts, the world equity market is trading on a price to earnings ratio of just over 20x. That means an equity earnings yield of 5% compared to the current 1.4% on the global investment grade credit index and 0.23% on the global government bond index. Valuations aren’t everything and equities have been cheaper on this relative value metric. However, when you consider the macro story, the technical at play in bonds and equities, and sentiment around the outlook - it’s hard not to be overweight equities going into 2021
I’m not sure what to make of this season’s premier league. Jose Mourinho’s Tottenham are top after 9 games, Leicester, Southampton, West Ham, Everton and Aston Villa are in the top 10, while both Manchester teams and Arsenal sit decidedly in the middle of the table. It is still early and if United had 3 additional points instead of a game in hand, they would be 6th or 7th. Liverpool look as they could set the pace again, unless they slip-up against Brighton this weekend while Tottenham face a fierce clash with arch-rivals Chelsea. A win for the Blues would put them above Spurs. It is quite fascinating and the lack of crowds is surely having an impact, reducing home advantage. The Christmas season is normally great for football, but it will be very different this year. Fans back in stadiums has to be a hope for the second half of the season. That would set us up nicely for the Euros next summer.
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