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Vaccines, massive stimulus and global economic recovery bode well for equities
Despite the past year’s global public health and economic crises, equity markets rose to record levels amid ultra-low central bank interest rates, massive fiscal stimulus and heightened expectations for global economic recovery. The COVID-19 pandemic remains the key challenge for the world’s economies in 2021, with case counts and fatalities reaching record levels once more. Renewed lockdowns to combat the virus will likely lead to some economic slippage in the months ahead, but there are reasons for optimism.
- The equity market rally broadened to include value, small caps and non-U.S. stocks.
- Our positive view on equities is supported by attractive long-term asset class fundamentals and a promising macro backdrop.
- We advocate investing over longer time horizons, careful rebalancing and adding more equities to portfolios.
An improving outlook for 2021
While we gladly turn the calendar page to 2021, many of last year’s challenges continue. The coronavirus is still spreading, and a third wave of infections could emerge in the spring. And while sentiment around vaccines is extremely positive, inoculating the world is a complicated endeavor that may not be completed in emerging countries until 2022 or later. Meanwhile, the amount of monetary and fiscal stimulus in the global economy raises the prospect of inflation rising faster than expected, creating a potential headwind to recovery.
However, investors should also consider the possibility of better-than-anticipated outcomes. The majority of people in the developed world should receive vaccinations in the second and third quarters of 2021. Economic recovery around the world has exceeded expectations thus far, and markets have responded positively to the U.S. presidential election. Despite potential near-term hurdles, we believe global growth will accelerate in 2021, while inflation is likely to remain benign – allowing central banks to keep interest rates lower for longer. This environment should lead to continued increases in corporate earnings estimates, driving equity markets higher.
Fourth quarter of 2020 set the stage for the New Year
The fourth quarter saw global equities extend their rally from March’s lows, fueled in part by the late-year approval and distribution of vaccines. In the U.S., the S&P 500 Index closed at a record high, and many other markets also posted significant gains. We recognize that optimism is elevated and stocks may look expensive by some measures, as investors pay up for a recovery in corporate earnings that is just beginning. Even so, with the exception of U.S. large-cap stocks, markets remain attractively valued.
Importantly, the equity market rally broadened from a handful of U.S. mega-cap technology stocks to a much wider range of companies, industries and regions that are more economically sensitive. These include value, small and mid-cap stocks, as well as industries hit hardest by the coronavirus crisis, such as airlines, hotels, casinos and energy.
U.S.: vaccines, politics and (finally) more fiscal relief
It was a remarkable fourth quarter and year for the U.S. stock market, with the S&P 500 jumping 11% in November alone. This move reflected successful trials of the Pfizer-BioNTech and Moderna vaccines, along with the market-friendly outcome of the U.S. elections, which initially pointed to a Biden presidency and divided party control of the House and Senate. That scenario was deemed likely to temper fiscal spending and limit the progressive push for corporate tax hikes and expanded public health care. Democrats’ success in Georgia’s runoff elections subsequently provided them with the slimmest of Senate majorities. This adds a degree of tax and regulatory risk for businesses, although major policy changes in those areas remain unlikely. Meanwhile, enhanced legislative prospects for further coronavirus relief and infrastructure stimulus should be positive for markets.
Following FDA authorization of the two coronavirus vaccines in December, attention has turned to the logistics of distribution. This will be a monumental task, and there are plenty of potential roadblocks. Epidemiologists estimate herd immunity could be reached this fall.
Assuming vaccinations proceed at a reasonable pace, the U.S. economy would likely experience solid growth beginning in the second quarter of 2021, as COVID-19-related restrictions are eased, people go back to work and everyday life gradually returns to normal. We would expect a great deal of pent-up demand for services such as surgical procedures, travel, entertainment, shopping and dining out to drive much of the improvement in economic activity over the next year or two.
In the meantime, the run-up in the S&P 500 makes U.S. large-cap stocks expensive at a price/earnings (P/E) multiple of 24.7 times the consensus 12-month forward earnings estimate of $165, versus a trailing five-year average of 18 times. We think the two vaccines and the passing of a $900 billion COVID-19 relief bill just before year-end could spur economic activity and earnings growth above 2019 levels by the end of 2021.
Such a scenario is possible, but the U.S. market may have already discounted much of the impact of these favorable developments. It seems clear to us that earnings estimates need to continue rising for U.S. equities to keep moving higher. Additionally, a rotation in market leadership – away from large caps and growth and toward smaller caps and cyclicals – may have already begun.
Against this backdrop, we suggest the following investment approach:
- Remain fully invested, but have a disciplined approach to rebalancing
- Cast a wider net for income and yield
- Manage risk and know what you own across portfolios
- Focus on high quality and relative value
- Use active portfolio management
China: Will its strong economic performance continue?
China has not been immune to the economic havoc wreaked by COVID-19. In fact, the country is on track for its slowest pace of growth since the Mao era. But set against the gloomy global backdrop, China’s economic performance has been exceptional. It will turn out to be one of very few economies to have grown at all in 2020, driven by recovering consumer demand and a related rebound in production, as well as a surge in exports of medical and work-from-home products. Seaport container traffic has seen a swifter and stronger rebound than domestic freight traffic, although the latter is now catching up thanks to consumer growth. As a result, China’s share of global GDP has jumped, probably by the most on record.
China’s share of world exports also took a step higher last year. Its trade surplus has averaged well over $50 billion per month since April, equivalent to 0.7% of global GDP. And its annual current account surplus, in global terms, is on course to be the largest of any country in 50 years. We expect a further, albeit gradual, recovery in the Chinese services sector in 2021, a steady improvement in retail sales and elevated investment growth in factories and infrastructure. Consumer behavior has changed irrevocably during the coronavirus era, and long-term trends in place before the pandemic will likely accelerate, benefiting key industries like e-commerce, fintech and health care.
That said, we caution against extrapolating these strengths too far into the future. The structural weaknesses in China’s economy – unfavorable demographics, rising debt burdens and diminishing returns on investment – are being papered over by government stimulus. We think the current situation may be similar to the 2007-08 global financial crisis, when China’s rebound obscured an underlying decline in trend growth that only became apparent a few years later.
Additionally, the recent strength in Chinese exports is unlikely to be sustained indefinitely, given that production levels overseas should gradually return to normal. Consumer demand will probably lose some steam as well, and exports of medical products may have peaked. Lastly, Beijing is determined to cool property markets, while social distancing measures remain in place.
Authorities will continue to focus on sparking domestic growth by encouraging internal manufacturing and consumption of locally made products. Overall, we expect annual real GDP growth to come in at 2.1% in 2020, down sharply from 6.1% in 2019, before rebounding to a range of 8% to 9% in 2021.
Going forward, we anticipate select opportunities in the Chinese stock market, driven by trends similar to those experienced in developed markets – namely, strong performance by the information technology, consumer discretionary and communication services sectors.
Europe: “whatever it takes” redux
Battered by the pandemic, European economic activity has been on a roller coaster ride. After plunging by a record 11.7% in the second quarter, eurozone GDP bounced back with 12.5% growth in the third. But more recently, due to renewed coronavirus lockdowns, GDP will show a decline for the fourth quarter. How bad will it be — and how fast might the region recover thereafter?
In the near term, the human and economic toll will be heavy, as new infections have surged in many countries and severe lockdowns have been reintroduced in Germany, the Netherlands and the U.K. A few countries, including France and Belgium, eased some restrictions in December, but the impact will not suffice to offset the broader damage. On the other hand, the ongoing rebound in manufacturing, backed by a need to replenish inventories, and solid export demand should soften the fourth quarter’s economic losses.
However, we see several potential positives emerging, including warmer weather in the spring and vaccination campaigns across Europe. Pent-up demand for simple social interaction should also provide a boost to GDP. Lastly, at its December meeting, the European Central Bank de facto vowed to once again do “whatever it takes” to ensure very favorable financing for the region’s households, companies and sovereign governments.
Our long-term, base case scenario for Brexit came to fruition in December with the EU/U.K. trade treaty clearing the necessary hurdles. In addition, the U.K. approved the Oxford/Astra Zeneca vaccine, with distribution targeted to begin as early as possible in January. On the back of this news, the pound sterling surged. The euro currency, along with the U.K. and eurozone equity markets, moved higher as well. Unfortunately, the recent eruption of a new strain of the virus in the U.K. has thrown a new wrench into the mix (or “spanner in the works,” as the Brits might say).
So how does the company earnings outlook fit into this picture? The initial improvement in earnings-per-share revisions, seen last summer, was clearly likely to stall as measures of business confidence in Europe were not strong enough to support analyst expectations. Odds are that earnings forecasts will pick up again in the new year, perhaps by as much as 45%, reflecting what we expect will be a quickening pace of economic activity.
As for stock market performance, European equities were fairly range-bound from last June until November, lagging on a global basis due to their lower weighting in technology and higher exposure to the financials sector. They rallied strongly in November, however, with many markets up well over 20%. Bank stocks advanced even more. This market rebound anticipates economic recovery leading to potential upside for company earnings growth forecasts. Positive earnings revisions are generally good news for equity markets, whose recent robust gains have clearly begun to factor them into expectations for 2021.
In this environment, our general industry views for Europe have not changed drastically. We still favor capital-light, high-return businesses. Such companies have the ability to expand their asset base quickly, thereby compounding shareholder returns at a much higher rate and over a longer time frame than the broad market.
Japan: cyclical stock opportunities are tied to global recovery
We don’t expect new Japanese Prime Minister Yoshihide Suga and his cabinet to make significant changes in economic policy. Nor is the Bank of Japan (BoJ) likely to shift monetary policy. Consumer inflation will likely continue to decelerate, in line with consensus forecasts of 0.5% year-over-year through the first quarter of 2021, reflecting weak oil prices. The renewed risk of deflation and ongoing U.S./China tensions should increase safe-haven demand for the yen, raising the specter of further currency appreciation. Historically, a strengthening yen has been negative for Japanese equities.
Like other countries around the globe, Japan’s economic recovery from last year’s pandemic-induced decline was swift. Inflation-adjusted GDP contracted 8.3% in the second quarter and expanded 5.3% in the third. But spending remains weak, with households and businesses alike bracing for a sluggish economic recovery as COVID-19 continues to weigh on confidence. The BoJ has reinforced this pessimism, continuing to warn that growth won’t recover strongly for some time. These comments lead us to believe the BoJ will maintain its accommodative policy stance.
Overall, the economic outlook for Japan remains soft. Employment has been holding up surprisingly well, but if recoveries in other countries stall or the spread of COVID-19 in Japan reaccelerates, the unemployment rate may tick up again, pushing consumer and business confidence to new lows.
In 2021, we see select opportunities in cyclical Japanese names benefiting from the global recovery. Among those, we would focus on service industries that have suffered the most during the pandemic. We see the greatest recovery potential in companies tied to automation/robotics, recruiting, real estate and autonomous vehicles.
Asia Pacific: pent-up demand in almost all countries
Many Asian equity indexes have climbed back to their pre-COVID-19 levels. We expect regional GDP growth to improve further in 2021, but the pace will vary by country. Positive signs are especially strong in China, Taiwan and South Korea, where the virus outbreak is under control and economies have all but fully reopened following austere lockdowns.
Governments and central banks across Asia are providing economic support via significant fiscal stimulus and liquidity measures. Countries in Northeast Asia have recovered more quickly than those in Southeast Asia and India, reflecting more effective COVID-19 containment and a resilient technology demand cycle. India, Indonesia and the Philippines are vulnerable given their higher infection rates and more limited policy support. Pent-up demand exists in almost all countries, but concerns persist about the strength of their banking systems and economic fragility linked to reliance on small- and medium-sized enterprises. We expect further interest-rate cuts by central banks in Malaysia, the Philippines and India.
Overall, economic growth momentum should improve in 2021, driven primarily by exports and business investment amid the gradually reopening global economy. We think conditions in the region favor active stock-pickers, emphasizing higher-quality growth companies with proven management teams and strong competitive positions. Sectors that look oversold to us include financials, materials and energy.
Emerging markets: an attractive investment for stock-pickers
Emerging markets (EM) countries, which now encompass seven-eighths of the world’s population, are on a somewhat different trajectory than their developed market counterparts. Amazingly, EM countries as a whole have spent less than 5% of GDP on coronavirus-related fiscal stimulus, compared with about 30% for developed markets. So we see potential for further stimulus if required. It’s clear that EM stock markets of countries that have done a good job controlling the virus are outperforming. Korea, Taiwan and China – which together account for two-thirds of the MSCI Emerging Markets Index – have essentially eliminated COVID-19 within their borders and reaped the benefits of superior stock returns in 2020 relative to other equity markets.
We expect style preferences in the EM space to shift back and forth between growth and value, depending on the stage of the economic recovery. In our view, the outperformance of growth companies in 2020 can be ascribed to fundamentals such as company earnings growth and balance-sheet strength. In 2021, as economic and earnings growth improve, investors may become more cognizant of valuations, allowing value stocks to finally outperform.
In addition, EM equities generally rise when the U.S. dollar falls, and vice versa. We are just coming out of a decade of EM equity underperformance and U.S. dollar strength – trends we believe are poised to reverse. Also favoring EM stocks are expectations of major reflation and higher fiscal expenditures, likely resulting in faster GDP and corporate earnings growth. We think EM earnings growth will rebound over the next two years after three years of weakness. Moreover, during periods of reflation, equities tend to outperform bonds, and EM assets typically outperform versus developed markets. Based on these factors, EM equities should represent attractive investment opportunities for stock-pickers.
Currencies: is more dollar weakness in store?
We expect a sustained softening of the U.S. dollar in 2021, as structural headwinds take precedence over short-term factors that have affected the value of the greenback over the past year. The dollar’s likely downtrend will be driven by several forces: the nation’s twin deficits (trade and budget), the Fed’s expressed willingness to tolerate higher inflation, global economic improvements and a changed U.S. political environment. In our opinion, 2021 may well be the year in which non-U.S. currencies finally get a chance to shine.
Outlook: transitioning to “normal” after a wild year
Following a tumultuous 2020, we look forward to the global economy transitioning to a period of “normalization” in 2021, supported by low interest rates, ample fiscal stimulus and, we hope, the eventual winding down of the coronavirus pandemic. Equities should continue to offer better return potential than fixed income. Our forecasts call for mid-single to potentially low-double-digit positive returns for equities over the year ahead, versus low-single-digit or potentially negative returns for sovereign bonds. In addition, historically low bond yields mean that fixed income may not provide as much protection against equity declines as it has in recent decades. This suggests that traditional views of the optimal portfolio mix should be re-evaluated to reflect the many structural changes affecting the global economy, return correlations and risk mitigation.
Based on its research, Nuveen’s Equities Investment Council advocates investing over longer time horizons, careful rebalancing and adding more equities to portfolios. Our positive view on equities is supported by attractive long-term asset class fundamentals and a promising macro backdrop. During the fourth quarter, we were encouraged by the style rotation into value, expanded market breadth that included small and mid cap stocks, outperformance by international equities, the steepening yield curve and the weakening U.S. dollar – all trends that signal we may be in the early stages of a new bull market.
Index Performance: FactSet; European Corporate Earnings: I/B/E/S; U.S. Corporate Earnings: Standard & Poor’s; Employment: RBC Global Asset Management; Russell Indices: FactSet, Russell Investments; Valuation gap: Alliance Bernstein.
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A word on risk
All investments carry a certain degree of risk, including possible loss of principal, and there is no assurance that an investment will provide positive performance over any period of time. Equity investments are subject to market risk or the risk that stocks will decline in response to such factors as adverse company news or industry developments or a general economic decline. Debt or fixed income securities are subject to market risk, credit risk, interest rate risk, call risk, tax risk, political and economic risk, and income risk. As interest rates rise, bond prices fall. Non-U.S. investments involve risks such as currency fluctuation, political and economic instability, lack of liquidity and differing legal and accounting standards. These risks are magnified in emerging markets. This report should not be regarded by the recipients as a substitute for the exercise of their own judgment. It is important to review your investment objectives, risk tolerance and liquidity needs before choosing an investment style or manager.
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