Outlook in 2021
For the moment the global economy continues to recover, although the pace has slowed. Unemployment rates have been lower than anticipated and the degree of Government response seems to have been a key factor. Australia has been amongst the fortunate so far, however lockdowns in Melbourne and in some parts of Sydney are timely reminders that the economic recovery can falter quickly.
We see the actual roll-out of an effective set of COVID-19 vaccines as essential to drive a bullish global economic recovery narrative for 2021. Economists with a positive outlook believe that the 2021 recovery should be strong as the pent-up demand from consumers unable or afraid to spend in 2020 is released. Australian, US, and German household savings ratios are currently at 19%,16%, and 15%, respectively, 2-3 times the pre-Covid-19 levels. In our view these savings levels add support to the position.
Whilst we agree the consumer is well placed to spend, we think the government stimulus and policy environment that arrested the losses, and started the recovery rally, in late March must continue. The key policy of low cash rates and bond yields are vital to maintaining confidence, which will allow government borrowing to remain affordable. We expect that this path will continue even if inflation starts to seep in.
Markets have a more challenging, although still positive story. Even though economic activity remains way below year-ago levels and corporate profits in developed countries have declined 15% or more during the 2020 calendar year, global share prices are up strongly, and above previous peaks in many markets, including the US. Corporate bonds are expensive again compared to government bonds (at 2019 levels) even though defaults are higher now. If we are lucky, stimulus and vaccines will allow markets to sustain these levels, providing time for the economy to catch up.
We believe the risk is low that government stimulus will be withdrawn prematurely. Thus, we do not expect large market falls to materialise. In our view, a more likely scenario is too much stimulus is applied, leading to inflation and eventually price risks for assets such as shares which tend to be supported when bonds yields are low. This could mean challenges arrive for the most expensive shares, in areas which have seen huge growth in the recovery rally, such as technology names and the consumer discretionary sector.
Both risks seem small compared to the possibility that the vaccine rollout does not go to plan, or more troubling, that economies fail to pick up even after mass vaccinations. This could happen if consumer and business expectations and confidence stay subdued. Worries over rising tax rates in the future to pay for higher government spending could be a factor holding spending back.
Overall our central expectation is positive for shares (more for Australia than the US), neutral for bonds, with the expectation that long global bond yields should move up slightly. We remain on the look-out for Responsible Investment ideas that can add incremental return.