With three approved vaccines now being rolled out, and the prospect of more to come, charity investors can look forward to the prospect of economic recovery in 2021 with more clarity. We believe it’s time to start moving towards a more positive stance on equities and other riskier assets — especially given the extremely high valuations of safe-haven assets like government bonds.
Investment risk and opportunities in a world recovering from the pandemic
The risk of a market correction in the nearer term remains elevated. Winter has brought a resurgence in coronavirus cases and additional lockdown measures, with falling high-frequency indicators of activity and leading economic indicators, such as Purchasing Managers’ Index (PMI) surveys in Europe.
Positive vaccine announcements fuelled a global stock market rally, with cyclical sectors that were negatively affected by the pandemic gaining popularity as hope grew about the world returning to normality. We believe some weakening in macroeconomic data suggests there may be a little too much optimism about the recovery, but a setback is by no means certain. The backdrop of extraordinary fiscal and monetary support may continue to enable investors to look through to a vaccinated economy.
Recovery’s winners and losers
Some sectors look more likely to benefit as the global economy recovers. In particular, the industrials sector has performed well recently due to its cyclical qualities. Elsewhere, the travel and leisure industry has been in the eye of the storm for much of the pandemic, so it could offer many opportunities if the economy picks up. However, these opportunities depend on how long it will take for working practices and consumer behaviour to return to normal.
For other industries, the outlook is more mixed. For example, oil should benefit from improving global economic growth due to higher oil demand and prices. Energy stocks bounced following the positive vaccine news but remain at historically low levels. While they could perform well during a recovery, the upside is tempered by longer-term uncertainty regarding the transition to clean energy. There’s also a possibility that Iranian oil supply could re-enter the world market under a more dovish Biden presidency, and drive down prices.
Mining is traditionally a highly cyclical sector, but it has been supported by the unique circumstances of the Covid-19 crisis. With China quickly tackling the pandemic and resuming normal industrial activity, iron ore prices stayed high and mining shares stayed strong. Still, they have suffered a setback recently over concerns that iron ore prices are now too high and could well fall from here, particularly as China reassesses the carbon footprint of its steel industry.
UK real estate is another highly cyclical sector and an economic recovery could lead to better prospects for medium-term rental growth and net asset values. Although there are opportunities, structural issues persist around retail and office demand, with the long-term impact of the pandemic still uncertain.
In terms of regions, Japan’s Nikkei 225 index has been one of the world’s strongest-performing stock market indices in 2020, even beating the S&P 500. Its resilience can partly be explained by a combination of sector exposure, stocks that have ‘growth’ and ‘quality’ characteristics (especially low debt levels and high cash balances) and stable dividends, while also benefiting from a weaker yen.
Asia, and particularly China, have had a strong year, but we see reasons for caution on the prospects for this to continue in 2021. For one, Asian equities tend to outperform when the gap between the region’s GDP growth and developed market GDP growth is increasing. The Covid vaccine would help consumption expenditure in Western countries more than elsewhere, as some emerging market countries may struggle to access sufficient numbers of vaccines at first.
Although PMIs and other leading indicators of economic activity continue to make multi-year highs in China, economists generally believe these will start to wane in early 2021. The profits of Chinese exporters have been supercharged this year, picking up market share from countries with longer-term lockdowns, amid increased spending on electronics, furniture and other household goods, particularly those offered by online sellers. In a vaccinated world, some parts — though not all — of this trend could unwind.
Focus on growth and quality
We still think it makes sense for charity investors to keep a bias toward companies with a track record of persistently strong growth. However, with approved vaccines coming out, a more balanced stance is now warranted, moving more towards the middle of the value-growth spectrum — looking for quality companies that have cyclical characteristics, and are available at a reasonable price.
Andrew Pitt is head of charities – London, Rathbones
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