Market volatility and positioning assets for the potential 2021 recovery
Investors could arguably be forgiven for forgetting what real volatility felt like, given the period of relative calm in the years running up to 2020. But last year provided a harsh reminder, as the coronavirus pandemic sent a shockwave of seismic proportions across markets worldwide.
A cursory glance at our own proprietary turbulence index, which aims to anticipate market shifts from low to high volatility, dramatically illustrates the extent of the swing last year.
If the measure moves sharply up, it indicates the market is entering a risk-off mood - at the start of 2020, it was hovering around the 13 mark. But by 28 February, it had leapt to 31 – and by 20 March it had rocketed to 149 as panic gripped markets.[i]
To put this into perspective, the last time the index got within touching distance of such levels was during the 2008/2009 global financial crisis.
However, thanks to extraordinary central bank stimulus which has propped up economies worldwide and the welcome arrival of vaccinations, the recovery is in sight; tellingly, our turbulence index ended 2020 in single-digit territory.
But it comes in the wake of markets recovering an extraordinary amount of ground. December saw both the S&P 500 and Nasdaq Composite indices set new record highs while global stocks overall, as measured by the MSCI World NR Index, were up 16% in the year to 31 December. And with an unprecedented amount of bond buying from central banks underpinning fixed income markets, government bonds achieved a total return of 10%.[ii]
At the start of 2020 investors’ minds were focused on geopolitical and macroeconomic challenges such as the US/China trade war and Brexit – and both remain concerns – but as we enter 2021 it is all about economic recovery and the mass rollout of vaccinations worldwide.
The global economy is now thought to have contracted less sharply in 2020 than previously expected, according to the Organisation for Economic Co-operation and Development. It now predicts global GDP to decline 4.2%, compared to its September forecast of -4.5%. It then expects growth of 4.2% in 2021, compared to its previous forecast of 5%, but it cautioned that the recovery could be stronger if vaccination programmes can be quickly rolled out.[iii]
Macro policy matters
Our Macroeconomic Research team are slightly more upbeat and currently expect overall global economic growth of 5.2% in 2021; 4.6% for advanced economies.[iv] However, with a new variant of coronavirus spreading around the world and countries including the UK going into new lockdowns, there are risks to the downside to this forecast.
Thankfully, policymakers and central bankers look set to stay the course in terms of pandemic-tackling stimulus. The European Central Bank has increased its pandemic emergency purchase programme (PEPP) by €500bn – taking it to €1.85tn – and has extended the support until at least March 2022.
Stateside we now have a path ahead, and despite the chaos which engulfed Washington at the start of the year, Democrat Joe Biden will be the 46th US President. The Democratic Party will also control the US Senate after a run-off election in January, which raised expectations of an enhanced emergency stimulus, going beyond the $900bn package agreed in December, probably ending up at approximately 10% of US GDP – versus 4% for the current package. However, Biden and his administration still have their work cut out in terms of containing the pandemic, as will other countries.
In short, while the outlook looks brighter that it did nine months ago, a myriad of challenges lie ahead and uncertainly will persist. With more than 93 million confirmed cases of COVID-19, and tragically more than two million deaths as a result, the key priority is the successful inoculation of the global population. But the distribution logistics remain deeply complex.[v]
Positioning assets for the recovery
Despite the more benign backdrop it would be unwise to take the present environment for granted. As 2020 starkly highlighted, volatility can return without warning. Therefore, maintaining a suitably diversified portfolio across multiple assets is key.
For our part, we believe the cyclical recovery should continue – provided central bank support does. Already the recovery in China is remarkable, with its CSI 300 Index hitting its highest level since the 2008 global financial crisis in early January.[vi] But financial markets are forward-looking and so have already discounted the current environment.
The focus is now on mid-2021 when hopes are for a large-scale vaccination campaign to be well underway, combined with an acceleration of activity leading to a stronger second half.
In terms of our asset allocation, we remain overweight equities and maintain a cyclical bias. We like Asia, and here we have exposure to both consumer goods and tech stocks.
Earnings growth should also hopefully accelerate - given the Nasdaq surged 45% in 2020, technology and its surrounding sectors will be ones to watch, given the planet’s accelerated reliance on all things digital in the wake of the pandemic.[vii] We believe the vaccine rollout should continue to lift market sentiment.
Regarding fixed income markets we are positive on credit and US government bonds. We expect the unprecedented support from both fiscal and monetary authorities should help to ease valuation and liquidity concerns – and monetary arsenal is very supportive, while the Federal Reserve has been clear in its intentions of support into 2023. Of course, one factor we need to keep front-of-mind going forward is that the cost of the pandemic is gigantic, and the invoice has yet to come.
[i] AXA IM Proprietary turbulence index
[ii] Marketwatch, 8 December 2020 / Factset, data as at 31 December 2020 (US dollar terms)
[iii] OECD Economic Outlook, December 2020 | Turning hope into reality – December 2020
[iv] AXA IM December 2020
[v] WHO Coronavirus Disease (COVID-19) Dashboard | WHO Coronavirus Disease (COVID-19) Dashboard (as of 17 January 2021)
[vi] Chinese stocks close at highest level since 2008 | Financial Times (ft.com) 5 January 2021
[vii] Factset, data as at 31 December 2020 (US dollar terms)
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