Multi Asset

The winners and losers in 2021: Which asset classes should investors potentially favour?

  • 2020 was not your average year but we move into 2021 overweight equities
  • We currently favour emerging market equities, those exposed to the green economy and European cyclical stocks
  • Key events to watch closely in 2021 include the deployment of the COVID-19 vaccine and the US’s budgetary measures

Hope and optimism returns in 2021

Last year was expected to be a moderate period for markets, and as investors, we approached 2020 enthusiastically - albeit with some caution. But it turned out to be a year like no other; markets endured severe volatility as the impact of the pandemic hit, lockdowns were introduced and there were cyclical rotations like never before.

Thankfully exceptional government and monetary policy - and the arrival of vaccines - provided markets, and investors, with some respite. We enter 2021 with an overweight in equities but markets are already looking beyond the winter. Indeed, we presently expect a return to some ‘normality’ around the end of the first half of 2021.

The chart below, often used to illustrate the benefits of diversification, highlights just how differently asset classes and regions can perform year to year – the key lesson being that the winners and losers are rarely the same from one year to the next.

In 2020, the US and European economies, as well as equities, were supported by the introduction of exceptional monetary and fiscal policy and via access to financing under very favourable conditions. The strong appreciation of technology stocks - well represented in the S&P 500 – largely explains the outperformance of the US index, up +18.4%, compared to the Eurostoxx 50 - where the tech sector is less represented - which gained just 5.51%.

Within emerging markets, the disparities have been strong. However, we note that Asia has been most adept at managing the pandemic, particularly in China, allowing it to reopen its economies earlier and limit the impact of the COVID-19. For its part, the Shanghai Composite CSI 300 index finished the year in positive territory with a +38.35% gain for the year.[i]

Commodities are a cyclical sector by nature and their prices were affected by 2020’s slowdown in economic activity, particularly in the energy sector and some metals heavily used in construction. In contrast however, gold - an asset typically viewed as a safe haven during times of market volatility - appreciated by 24% in 2020.[ii]

For 2021 we currently have a preference for:

Emerging market equities

We are positive on Asia, particularly China. Here we are looking to take advantage of the burgeoning digital economy and the growth in consumption. We have significant exposure to the technology and consumer goods sectors, and like companies such as Chinese technology firm Tencent, Tal Education Group, dairy products producer Inner Mongolia Yili Industrial and musical instrument manufacturer Yamaha.[iii]

Green economy equities

The collapse of growth in 2020 led governments to implement major fiscal stimulus plans, with many announcing climate-friendly rehabilitation initiatives. The European Union unveiled a recovery deal, which included some €550bn dedicated to green initiatives. The energy transition is likely to generate considerable investment in green infrastructure over the next 10 years and we believe companies exposed to the renewable energy sector have the potential to generate earnings growth above the market average.

Furthermore, such firms are generally well rated from an environmental, social and governance (ESG) standpoint, and their price should therefore potentially be supported by significant investment inflows into the ESG universe. Within this area theme, we favour utilities that earn a significant portion of their revenues from renewable energy, as well as industrial companies producing electrical equipment, and technology companies providing semiconductors in renewable energy.

Cyclical stocks in Europe

Recently, value stocks, often found in the financial, energy and highly cyclical sectors, have outperformed growth shares, which typically belong to the technology and non-cyclical consumer goods industries. Generally, the level of earnings recorded by cyclical stocks varies according to economic conditions and market cycles. In 2020, cyclical stocks suffered significantly but these lower valuations could represent an attractive entry point.

With the prospect of a more ‘normal’ economic and social backdrop hopefully in sight, we believe quality cyclical companies could potentially see their earnings benefit in 2021. But such an outcome will depend on the pace of recovery and its impact on the yield curve; a steepening of this would benefit financial stocks, but less so for the interest rate used to calculate the discounted earnings of growth stocks.

Asset classes: Where we see the least potential in 2021

In our view, cash, the US dollar and sovereign bonds have the most limited upside potential in 2021. However, we will use these assets during difficult market phases, where they can act as buffers. In addition, they are all highly liquid, so we can sell them quickly if we wish to increase our expose to riskier assets to capture phases of recovery.

Cash, government bonds and credit

Given the backdrop of deeply subdued interest rates, cash remuneration is at historically low levels and as such the short and medium-term outlook remains muted. In fixed income markets rates and credit spreads are also stuck in the doldrums, meaning that carry (rates plus spread) remains very unattractive in the long term while yield curves have flattened sharply. Presently central bank support is expected to continue, and we do not expect monetary policy to tighten in Europe or the US in 2021; the size of central banks' balance sheets is not set to be reduced in the short term. We believe that interest rates are bound to remain low for a prolonged period, although they are likely to rise gradually as inflation partially normalises, thanks to a more pronounced rebound in growth, which should hopefully materialise in the second half of the year.

The US dollar

The US dollar is expected to fall further in 2021 and continue to reduce its overvaluation relative to its long-term fair value, as defined by purchasing power parity. The vaccination campaign and the rebound in global growth that it will deliver should support market sentiment and reduce appetite for the safe-haven characteristics of the greenback. The Federal Reserve is expected to keep interest rates at their current level until the end of 2023 and in this context, the yield delta with the rest of the world makes the dollar significantly less attractive than before and no longer justifies its current level. In addition, the widening of the US budget and current account deficit is likely to weigh on dollar demand.

Looking ahead: Four things to watch in 2021

  • The deployment of the COVID-19 vaccine. Its production and efficiency of its distribution, its success rate and hopefully, eventual collective immunity.
  • The implementation of US budgetary measures, particularly with a Democratic-controlled Senate.
  • European bond issuance. We believe that the introduction of the €750 billion “Next Generation EU” stimulus fund in Europe represents a major institutional step forward in the pooling of debt.
  • Communication around the monetary stimulus exit strategy. What about the sustainability of support measures in 2021 and 2022? The economy's hyper dependence on stimulus will have to normalise gradually, but difficult situations (like in 2013 and late 2018) cannot be ruled out. Given that the markets are on the receiving end of ultra-accommodative monetary policies, a communication error by central bankers could lead to a revolt in the markets.

2021 will be a complex period but hopefully calmer than 2020. We will continue to actively allocate in line with our convictions. The present environment remains uncertain and despite the prospect of recovery, stock picking will remain the main source of alpha. Naturally, we will be agile and look out for market signals that indicate potential tactical opportunities.

[i] Source: Factset, Data as at 31 December /2020 (in US dollar terms)

[ii] Source: Bullionvault as at 31 December 2020 (in US dollar terms)

[iii] Stock examples are for explanatory/illustrative purposes only. They should not be viewed as investment advice or a recommendation from AXA IM

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