After perhaps the most extraordinary year that any of us has experienced, the outlook for the coming year is more than usually opaque. We are usually able to draw on established valuation metrics and historic parallels to provide a basis on which to form opinions but almost none of them seem now to have any relevance. There is no precedent for the current situation because there has never been a health-based recession before: they have always been financially-based and the factors that produced them take time to unravel – usually years – whereas this problem may be substantially solved in a few months depending on the development and roll out of vaccines and therapeutic treatments. If all goes reasonably to plan, the huge hit to GDP world-wide may be recovered in the course of 2021. As markets look forwards, that almost means now.
The unevenness of the growth outlook is also reflected in the major economies. China, where control of the pandemic has apparently been more effective, has swiftly returned to a near pre-pandemic growth pattern. Whereas other major economies, such as the US and Europe where the virus has perhaps been less well controlled may experience a less rapid economic recovery. The economic problems have also been extraordinarily sector-specific: leisure, hospitality, and air transport for example have been severely impacted while many other service sectors have hardly been affected.
Add to all of this, the unprecedented responses from governments around the world which may well introduce entirely new strains in the financial system, with borrowing levels not seen outside wartime, which nobody has much idea how, or even whether, to unravel. Zero interest rates make the valuing of future cashflows using established principles nonsensical.
One could conclude from all this that not only do we not know where we are, but we do not know where we are going either, which makes planning finances tricky, to say the least! However, it may be possible to tease out some indications on which to base portfolio construction, while remaining prepared to change tack, maybe sharply, as the situation evolves.
This may eventually be seen as a profound but ultimately temporary setback. Social activities and the industries most reliant on them are likely to rebound, as they have following past pandemics. Consumer hesitancy from fear of catching Covid-19 will determine the path, but eventually social activities ranging from concertgoing to travelling are likely to resume. While the immediate pain of job losses is great for many families and industries, a reasonably positive outlook for vaccination and treatment coupled with the additional policy support provided by Government should lead to a limited impact of such job losses.
The acceleration of automation and the use of digital technologies brought about by the pandemic mean that the sectors that are better able to operate in such ways, and the technologies on which they rely are likely to thrive and prosper.
On a more pessimistic note, this crisis has altered the preferences for certain government policies, such as a more forceful effort
by central banks in some economies to drive up low inflation coupled with more aggressive spending by fiscal authorities amid economic headwinds. These measures are unlikely to be reversed quickly, which may therefore produce potential new economic risks to be faced.
Valuations
There are, hardly surprisingly, sharply differing views about current equity market levels. The consensus is that most markets are either fully valued or over-valued. The US market is an extreme case with its concentration in the tech stocks, known as the FAANGs (Facebook, Amazon, Apple, Netflix and Alphabet – formerly known as Google) but that acronym is now out of date as it does not include Tesla which has gone up 6-fold in the last year, making Elon Musk the world’s richest man. Excluding them, perhaps the rest of the US is not over-valued, but is it right to do so? One can make a case for the other main markets – Japan and Europe – being reasonably valued too, while as always China cannot be valued sensibly. The only significant market – at least for UK investors – that looks cheap is our own and that may be for good reason, at least until we see the how post-Brexit scenario will evolve.
What to do?
The mood currently is one of cautious optimism and, while inflation remains subdued and interest rates low, this seems likely to remain the case. Remaining fully invested is therefore appropriate with a significant stockmarket weighting. Remaining wary is, however, even more important than usual because movement on the inflation/interest rate front would be the signal for greater caution. That seems the rational approach but bull markets, which this undoubtedly is, have a habit of breaking for irrational reasons and the timing of these breaks is, historically, unpredictable.
Summary
What to do next of course depends on your individual position, attitude to risk etc, but in summary we believe the following approach is sensible:
-
- Stay invested
- Gradually reduce risk by moving out of high-growth, highly valued markets and sectors
- Buy lower-risk sectors, particularly where income-producing so as to be able to wait out a market crash should it happen
- Watch inflation trends carefully and be ready to act
If there are any matters you would like to discuss in relation to this commentary, or any aspect of your financial planning, then please do not hesitate to get in touch.