Investing in equities in 2021 - why they can keep on rising

It was very clear last year that there was a huge difference between the performance of the real economy and stock markets as the world tried to deal with COVID-19. While economies everywhere shrank in terms of GDP (China was the only country to eke out a positive growth rate in 2020), equities in most countries had a great year.

So, at the beginning of this year, with the UK in a strict lockdown and many other countries facing various restrictions and new variants of the virus, you could rightfully be asking whether things could change and whether we should therefore be more cautious in our investments. Can equities keep rising in 2021?

In our most recent webinar, Chief Investment Officer, Michel Perera addressed this very question, along with others from our clients. You can watch a recording of the webinar or read the article below.

Why does our outlook for equities remain positive?

Money supply from central banks has gone through the roof and they won’t raise interest rates even if inflation picks up

In the US in 2019, money supply rose 6.7%, in 2020 it went up more than 25%; in the UK, we went from 1% to 11.7%; in the eurozone, up 11%. Central banks have also pledged not to raise interest rates for a long time. The US Federal Reserve (Fed) said not until at least 2023.

Governments are supporting the unemployed and businesses to make sure they can survive the pandemic

Fiscal relief has been provided in many countries in the world including Europe and Japan, with the US providing a level of generosity never seen before. Governments are trying to make sure that those whose livelihoods have been ruined by the virus can still survive so that society can function properly, while those who work from home can keep spending and boosting the economy. The unprecedented fiscal spending is designed to tide us over until the vaccine creates herd immunity and we can go back to normal.

The net result is that we are starting a brand-new economic cycle with all the tailwinds behind us and a promise that tailwinds won’t turn into headwinds as soon as the situation improves. This is better than previous starts to economic cycles (recall fiscal austerity after the 2008/09 financial crisis). In this environment, we feel comfortable we can concentrate on selecting investments without worrying too much about politics or the economy.

Can we really disregard the ongoing challenges COVID-19 presents?

While COVID-19 continues to impact our collective health and the economy, it’s hard to believe this won’t be reflected in the markets. But the answer is that the sectors damaged, sometimes decimated, are a very small part of the equity market (travel and leisure, hospitality, even retail). Even the sectors that suffered indirectly, such as energy and financials, are also a small part of the markets, with perhaps the exception of the FTSE 100. On the other hand, the beneficiaries from the lockdowns (technology, healthcare and online shopping) represent a larger share of risk markets, particularly in the US, China, the emerging markets and Japan.

What is the potential impact on markets of the huge money supply from central banks and how will we pay for the unprecedented levels of fiscal support from governments?

The risk is that we get inflation and higher interest rates which would be bad for asset markets which are priced for low rates for a long time. However, the way that money moves around the economy now is much slower than before, so you can keep adding more money and so while inflation is a key risk that we monitor, it’s not something we need to worry about right now.

Further, as mentioned above, administrations in the US and the UK have pointed to a scenario where they will be very slow to raise rates and withdraw fiscal stimulus, no matter what happens with inflation.

The huge support from governments has seen fiscal deficits balloon: in the US, from 4.7% of GDP in 2019 to 15.8% in 2020, in the UK, from a 2.1% deficit to 18.7% and in Germany, from a 1.5% surplus to a 4.8% deficit.

Ultimately, deficits must be paid for but we believe we can maintain this structure for a few years before it becomes a problem. Higher taxes cannot of course be ruled out and businesses and individuals will need to prepare. However, the most significant areas of taxation to get rid of the debt won’t be wealth taxes like CGT (although this could rise), it will more likely be income tax and VAT which have the biggest contributions.

Could anything else go wrong to change our positive view on equities?

Social inequality

The main concerns for the future are the social implications of the pandemic. This is the second economic crisis in a row to hit lower-income more than upper-income classes. The gap between these strata within society has been exacerbated. Countries with huge deficits, will at some point have to balance their books and higher taxes may well come up in the future.

Politics

The main concerns are the challenges posed by implementing Brexit in the UK, and in the US, the cold war with China. As long as the cold war between the US and China does not become hot, markets may have little to fear from the competition between both superpowers, whether in the technology space or in financial markets. As a foreign investor, we can pick the best of class in either country. If geopolitical tensions get to the stage where an investor has to choose between the US and China and cannot do both, then we may have to re-consider our strategy, but for the time being we have the option to pick winners anywhere.

Overheating in the economy

Paradoxically, one of the risks ahead is too much success. If the vaccine works perfectly and our countries achieve herd immunity by the autumn or even the summer; if the economy recovers smartly and strong growth brings us back to where we started 2020; if we all start behaving normally again as all lockdowns are eventually lifted, there is a risk of overheating in the economy. We could find that equities correct due to too much growth. Fortunately, we think that inflation will not cast a long shadow over the US economy or anywhere else. Price spikes will probably arise but should be limited in time and impact. Besides, the Fed has told us very clearly that they do not plan to raise rates prematurely and kill this incipient recovery.

What questions are our clients asking right now?

Our open client call/webinar allowed attendees to ask specific questions of our investment experts, as follows:

Will the stamp duty holiday be extended?

It’s quite likely that it will be extended – in essence, it’s not going to make a huge difference to debt levels so it’s likely to continue to encourage the housing market which is important to the economy.

From a stock market perspective, sectors that were beaten up by COVID-19 (travel, retail and hospitality) motored ahead after the vaccine rollout. Can these companies continue to move upwards in the current environment? 

The ‘easy yards’ (as they say in the US) have already been made so any further gains are likely to be much smaller now. To continue, it would need the COVID-19 recovery to come through with more vaccinations.

Could technology regulation affect the sector’s performance in 2021?

After a stellar year in the tech sector, it would be no surprise to see a pause for breath. However, even with higher regulation, the underlying drivers of the sector from artificial intelligence and cloud computing to electric cars, will continue for many years, so growth is likely to continue.

Will weakness in the US dollar continue?

There is room for it to continue to be weak – as growth accelerates across the world, the prospects for other areas will improve and the US dollar is likely to suffer. As the reserve currency of choice, it tends to do better when others do badly.

Where could investors look for opportunities to invest?

ESG (environmental, social and governance)

ESG companies were massively rewarded last year, whether environmental businesses, battery chains or even cyber security. More is likely to come this year and next, with President Biden placing green energy at the centre of his policy programme. Companies that deliver on the environment are likely to be the stars in the stock market.

Manufacturing

The recovery that started in China has spread widely to the manufacturing sector globally. It is unfortunate that manufacturing is only a small share of developed economies these days, but the recovery helps. Markets and sectors that benefit from the pick-up in industrial activity are of great interest to us now.

Technology

The technology sector has lagged some other sectors in the last few months which have benefitted from the vaccine rollout, but we believe that the case for new, disruptive technologies is still very strong. The high profitability of these firms gives them the ability to invest and simultaneously return money to shareholders for many years.

UK

The UK market remains to be a stock-picker’s paradise. Brexit in itself won’t make a huge difference to the relative attractiveness of the FTSE but the companies that can make money out of it will be in demand. Selecting them is the tricky part and it’s exactly what we are focusing on.

Defensive alternative investments

The small rise in government bond yields in the last few months has not made them much more attractive. Gilts in the UK, Treasuries in the US and various European and Japanese government bonds cannot protect against future inflation with the very low rates they offer. Conservative portfolios which need a balance of risk and non-risk are better served looking for defensive alternative investments, gold and corporate bonds over government bonds.

In summary, the backdrop is positive for investments and we should all be focusing on selecting the best ideas rather than worrying about the direction of the markets, even with lockdowns and new variants of the virus.

Speak to one of our experts

If you have any questions about the current environment or about your investments, please get in touch with us or email questions@canaccord.com. 

Please remember, if you hold an account with Canaccord, you can check your portfolio value at any time, through Wealth Online or by getting in touch with your Investment Manager.  

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Investment involves risk. The value of investments and the income from them can go down as well as up and you may not get back the amount originally invested. Past performance is not a reliable indicator of future performance.

The information provided is not to be treated as specific advice. It has no regard for the specific investment objectives, financial situation or needs of any specific person or entity.

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