A recovery in the job market and record levels of household savings should lift consumer spending worldwide. Investment will also get a boost from rising profits and maintenance cycles. Trade is also recovering fast and even though spending on services will remain well below pre-COVID levels, the sector should gain strength, too.
Investors should also expect the environment to become a greater priority in 2021 – fuelling growth in sectors like clean energy. Joe Biden’s victory in the US presidential election will provide further momentum to this shift. Across the globe, green investment will form a key part of fiscal stimulus packages, feeding into a strong and synchronised economic recovery.
Pictet Asset Management’s business cycle indicators point to to mid-single digit growth in world gross domestic product (GDP) in 2021, but positive base effects cannot hide the long-lasting damage caused by the pandemic. Pictet Asset Management estimates that the fallout from COVID-19 will permanently reduce global GDP by 4 percentage points. It will take years before the global economy can go back to pre-COVID-19 levels.
The growth gap between emerging and developed markets will widen further to the benefit of both developing world equities and debt, thanks in a large part to China – the only major economy to avoid a contraction this year. From industrial production to car sales and exports, most of China’s primary economic activity indicators are already back at or above December 2019 levels, and set to expand further. Retail sales have lagged slightly but Pictet Asset Management expects private consumption to recover gradually in the coming months.
The near term outlook for the US economy is dependent on the fiscal relief programme currently under negotiation. A package north of USD1 trillion – Pictet Asset Management’s base case scenario – could push US growth above 5 per cent next year.
Globally, though, Pictet Asset Management would expect fiscal stimulus to be reduced compared to 2020 – not through a return to austerity policies, but because Pictet Asset Management expects fewer new measures. Central banks will act as “shock absorbers” by keeping rates low and maintaining stimulus. However, liquidity conditions are still likely to deteriorate. Pictet Asset Management estimates that the total assets of major central banks will expand only USD3 trillion next year. This is double the yearly average seen the 2008 financial crisis but significantly below this year’s record USD8 trillion.
History tells us that this matters for risk premia. Pictet Asset Management´s models suggest that global equities’ earnings multiples could contract by as much as 15 per cent next year, but this is likely to be more than offset by an approximate 25 per cent surge in corporate profits.
Government bond yields in the developed world are likely to move gently higher tempered by central bank action which could include balance sheet expansion by the European Central Bank and yield curve control by the US Federal Reserve.
Fixed income and currencies: conditions improve for emerging bonds, TIPS
Even if Pictet Asset Management expects the global economy to recover strongly from the ravages of the pandemic in 2021, the surge in GDP growth is unlikely to lead to a sharp sell off in developed market government bonds. That’s primarily because central banks won’t take any unnecessary risks.
Both the ECB and the Fed will do whatever is required to keep policy accommodative and ensure a self-sustaining recovery. For the ECB that means more bond purchases and the continuation of cheap loans to banks; for the Fed, that could involve adding yield curve control (YCC) – anchoring policy to specific bond yield targets – to its anti-crisis measures.
All the while, inflation will remain below central banks’ targets. Nevertheless, the combination of strong growth and rising commodity prices will feed through to a moderate pickup in inflation expectations. That’s a dynamic investors should pay attention to: while it translates into only a very gentle rise in nominal government bond yields in 2021 (Pictet Asset Management sees 10-year Treasury yields edging up to 1 per cent) it points to a further fall in real yields.
This would provide a boost to US Treasury Inflation-Protected Securities (TIPS). Pictet Asset Management expects them to outperform all developed market nominal bonds; real yields should remain close to -1 per cent as inflation expectations gather momentum.
In a year that will see healthy global growth and increased international trade, emerging market local currency bonds should also fare well. They are among the very few fixed income assets offering a yield of above 4 per cent. Adding to their investment appeal is the prospect of a strong rally in emerging market currencies – which should unfold as the global economy recovers and as trade tensions ease under a Biden administration. Currently, emerging market currencies are close to 25 per cent undervalued versus the US dollar according to Pictet Asset Management’s model. Chinese renminbi debt should have a particularly strong year – not only benefiting from its attractive yield compared to developed world bonds but also from the asset class’s increased presence in mainstream bond benchmarks.
Prospects for developed market corporate bonds are mixed. High yield bonds are not especially attractive at this juncture. To seasoned fixed income investors that would seem unusual as history shows sub-investment grade bonds outpace equities during the final throes of a recession and in the early phase of a recovery. Yet the problem this time round is that high yield debt is already expensive.
In the past, high yield bonds’ outperformance has taken hold whenever the gap between their real yields and stocks’ dividend yields was above 10 percentage points. The strong run would then fade as the yield gap approached 3-5 percentage points. With the yield gap currently standing at 1.5 percentage points, however, the scope for high yield bonds to register significant gains appears very limited.
Investment-grade corporate bonds are more appealing – their returns compared to those of US Treasuries are low compared to the levels normally seen at this point of the economic cycle.
When it comes to currencies, 2021 doesn’t promise to be a good year for the dollar. There are several reasons why. For one thing, the greenback’s allure should fade in the face of a synchronised global economic recovery. Then there’s the prospect of a surge in the US budget deficit and continued intervention from the Fed – a fiscal and monetary expansion which will likely place further downward pressure on the currency. The dollar continues to trade well above what fundamentals – such as interest rate and growth differentials to the rest of the developed world – suggest is fair value.
Gold should continue to rally – Pictet Asset Management forecasts the gold price will hit USD2,000 by end-2021. Continued quantitative easing by global central banks, a weaker trajectory for the dollar and real rates dipping further into negative territory should all underpin demand for gold.
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