The UK joined the cyclical rebound due to the very assets which have caused it to lag for the majority of 2020 as commodities, banks, industrials and energy stocks recovered strongly.
UK equities recorded their strongest month since May 1990 in November, and positive Brexit news saw positive returns continue into December. The fact that UK equities were down almost 15% in 2020, despite this significant bounce, shows just how far they had fallen in the year and recorded their worse year since 2008. The lack of exposure to technology names in the index is often cited as a factor and by contrast US technology stocks were up over 43% for the year, their best year since 2009.
Traditional household names have struggled to evolve in the new environment and even M&S recorded its first loss since 1926. Whilst clearly not comparing on a like for like basis, the numbers being generated by Apple are truly mind blowing. Their fourth quarter sales were more than $111bn, up 21% year on year! More online activity is obviously fuelling demand for new technology and Apple is the market leader. Apple now has 1.65 billion active devices globally, including more than 1 billion iPhones.
All-time highs fuelled by stimulus packages
Wider markets in the US also finished the year at all-time highs, with US equities rising over 12% in the quarter. US Congress agreed a $900bn stimulus package which added further support to markets but also weakened the US Dollar. The cumulative amount of stimulus in the US could reach $4trn which would see a US federal deficit of over 25% in 2021. To put that figure in context, that level was 11% during the Great Financial Crisis (‘GFC’) and 27% during WW2!
In the UK, the Bank of England (‘BoE’) has ramped up its bond buying programme to £895bn and agreed to continue to buy throughout 2021. In the Eurozone, the European Central Bank (‘ECB’) president Christine Lagarde agreed to increase their Pandemic Emergency Purchase Programme by €600bn, increasing the total to €1.35trn. The ECB will also likely extend its bond-buying programme by €500bn and most importantly commit to reinvestment until mid-2023. The widespread impact of this has seen yields on Spanish 10 year bonds falls to zero and Italian bonds are now negative out to 5 years.
Globally, sovereign debt is estimated to rise to 125% of GDP in developed markets and 65% of GDP in emerging markets according to IMF estimates – in the US this figure is 132%.
Joe Biden’s presidency will likely bring less change in US policy towards China, however the increase in China’s relative economic standing will not have gone unnoticed. Estimates show that the global economy may have shrunk by 3.5% in 2020, the largest contraction since the Great Depression. China however is coming out of the pandemic in the strongest shape having successfully contained the virus and successful stimulus has seen its economy return to pre-pandemic levels.
Indeed it was the only major economy to avoid a contraction last year and likely to have grown by c.2% and it may account for 30% of global growth in 2021! China has become the largest recipient of foreign direct investment in 2020 overtaking the United States; it has also become the world’s largest exporting nation in 2019 accounting for 18.4% of GDP or $2.6trn.
By contrast, the UK is likely to have contracted by 10% but it is anticipated to grow by almost 4% in 2021 – indeed it is widely felt that economies will rebound strongly in 2021 with global growth estimated at 4.8% for the year.
Dollar, gold, interest rates, inflation
A weaker Dollar supports commodity prices, gold and emerging markets which rose almost 20% in the quarter. Gold reached an all-time high of $2,075 per troy ounce in August and whilst flat in the fourth quarter, it was up 6.8% in December and almost 25% in the year. It was a more volatile year for the precious metal with some correlation to risk assets. It is also a beneficiary in a low interest rate environment and was clearly helped by some market commentators stating that the Fed is likely to keep rates at rock bottom levels for many years, guided by their more flexible approach to inflation.
One concern is that pent up consumer demand and the increase in money supply could lead to inflation. The prospect of inflation has already seen a rise in commodity prices (as well as a weaker Dollar).
One question we ask is what can alter the current low interest rate environment?
Whilst government spending is high, interest costs are forecast to fall in coming years due the drop in interest rates – the same is true for corporates. Inflation has been muted since the GFC, and if it does come through, the impact could be significant. Is it likely that governments will tighten policy if inflation does start to rise? The market seems to think not! There is no escaping the fact that inflation erodes the purchasing power of cash (along with debt) and we should be mindful as to how inflation may impact government policy and the knock on impact to bond and equity markets.
Impact on the bond market
The yield on the 10 year US Treasury rose strongly in the quarter. It finished the third quarter around the 70 basis point level and finished the year at around 91 basis points having briefly looked to breach the psychologically important level of 1%. Yields rise when bond prices fall, and the potential for increased government spending implies increased government borrowing, thus a larger supply of bonds driving the price down.
In the UK, the yield on a UK 10 year gilt fell modestly to 0.20% in the quarter. Sterling appreciated strongly against the US Dollar rising from 1.29 to almost 1.37 as Brexit negotiations accelerated. Sterling also benefitted from being a ‘risk on’ currency as equity markets, and in particular UK equities, rallied strongly.
Are we in bubble territory though?
There are some investors out there who are concerned that we are in bubble territory. There are certainly some signs such as the soaring price of Bitcoin, which rose from close to $10,000 to near $40,000 in the last quarter of 2020.
New companies are listing and seeing their share prices double on their first day of trading. Government borrowing is at eye watering levels as is the ownership of the debt – the Federal Reserve, ECB, Bank of Japan and BoE own financial assets that now equal 54.3% of their countries’ combined GDP. In 2018 that figure was 10%. Despite the backdrop, the US housing market also rose, with residential investment rising at its quickest rate since 1983. With most stock markets at historically high levels and some over-confidence in markets, should we be concerned?
There are clearly risks, such as a resurgent virus and overly bullish sentiment but household finances are in good shape – monetary and fiscal injections have left households with money to spend on eating out, travel and holidays once restrictions are removed. Government spending is expected to remain at high levels and it is being bought up by central banks.
All signs indicate that low interest rates will continue and we are likely to see a strong recovery in corporate earnings in 2021 and further into 2022, this will likely entice investors into risk assets.
It will not be without volatility and we should always be mindful as to how we would view our investments should we see a significant double digit correction in markets. Now is the time to consider whether we are invested in the appropriate strategy for us and our families, not after the event!
Toby Sturgeon is Global Head of Fiduciary Investment Services at ZEDRA. ZEDRA is a global provider of active wealth, corporate and fund solutions. The firm’s highly experienced teams deliver tailored high quality solutions to clients who include high net worth individuals and their families seeking diversified active-wealth solutions, as well as, medium to large sized companies, asset managers and their investors.