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While the start of 2021 looks to be a continuation of 2020, there is a great sense of optimism that, by year end, life will have returned to somewhere near normal as COVID-19 vaccines are rolled out globally.
It is fair to say that 2020 will go down in history as one of the most challenging years for humankind as the world grappled with a global pandemic the likes of which have not been seen in 100 years. While the start of 2021 looks to be a continuation of 2020, there is a great sense of optimism that, by year end, life will have returned to somewhere near normal as COVID-19 vaccines are rolled out globally.
From an investor perspective, the consensus view is that the global economy will experience extremely strong economic growth in 2021, on the back of highly accommodative monetary policy and a general willingness of governments to spend. This should be a great time to invest, right? Unfortunately, investing is never that simple.
While 2020 witnessed the largest economic drawdown since World War II, equity markets, which experienced rapid declines in February and March, rebounded strongly in the second half 2020 with many now at all-time highs. So, what drove this market optimism? Simply put, it was the unprecedented magnitude of the response by central banks and governments, combined with human ingenuity in developing multiple vaccines in a short period of time. These factors have been great for returns in 2020, but they do present challenges for 2021 and beyond.
For 2021, the key for returns will be the strength of earnings growth as economies begin to gradually open-up. In most cases current market pricing already includes reasonably high expectations, so this presents a headwind for further material gains from here. Additionally, while some economies, such as Australia and New Zealand, are already well on the recovery path, others will take longer before the shadow of COVID-19 recedes and lockdowns can disappear. As investors, we must expect that any recovery will not be in a straight line, but we also need to be cognisant that we are not out of the woods yet, and this presents a risk.
From an opportunity perspective, there has been a mindset shift over the past few years and now a growing acceptance of the importance of government stimulus in driving the economic recovery. This means more government debt and larger budget deficits, both of which were taboo topics only a few years ago. Of course, governments are being ably assisted by the willingness of central banks to keep interest rates, both short and long term, at close to all-time lows. Hopefully, a large part of this spending is directed towards productivity enhancing infrastructure that will underpin growth for many decades. Such programmes could provide a once in a generation opportunity for investors.
Another interesting observation from 2020 is that it demonstrated what humanity is capable of when there is a real sense of urgency (i.e. vaccine development). In this regard, the drum continues to beat louder in relation to climate change and the desire for action seems to be increasing. I have a feeling we will probably look back in twenty years’ time and reflect that the early part of the 2020s was when the world really took climate change seriously. Once again, this should lead to investment opportunities, many of which probably don’t exist yet.
In thinking about risks, we need to be cognisant that markets are showing many of the signs of what would typically be indicative of late cycle behaviour. Some examples include the greater involvement of the retail investors (as exhibited by the recent GameStop event) or special purpose acquisition companies (SPACs), which are effectively shell companies with the promise of high future returns, raising over $80 billion in 2020, easily eclipsing the previous record of $6B in 2007. History has shown us repeatedly that chasing risk to achieve a return is a strategy fraught with danger and it is unlikely it will be any different this time.
From an overall portfolio perspective, the greatest challenge is building a well-diversified portfolio. This is not so much driven by the high valuations in different growth asset markets, which all things being equal will lead to lower future returns, rather it is a result of the low yields (negative in many cases) on government bonds and cash which have traditionally played the defensive role in portfolios. In this environment the importance of portfolio diversification cannot be underestimated.
So, as we look forward to 2021, and beyond, there is a growing sense of optimism after what has been an extremely challenging 12 months. While it may not be time to book that next overseas holiday, by the end of 2021 we should be back to life somewhere near to “normal” as it was before COVID-19. This is something to be optimistic about.
JANA and University of Melbourne collaboration
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