By David Crosoer and Professor Prieur du Plessis
MOST NEW YEAR’s resolutions don’t last the first month.
Similarly, forecasters are often guilty of optimistically anticipating the reversal of troublesome trends from the previous year.
So is it unrealistic to enter 2021 thinking the challenges of the last year are mostly behind us? Here we focus on five possible key reversals (in descending order of likelihood), and assess their implications for investing in 2021.
Pandemic to be controlled
The announcement late last year of multiple effective vaccines (developed in close to half the time many experts felt was possible in a best-case scenario) has undoubtedly increased the likelihood of a return to normalcy at some point this year, notwithstanding the more virulent strains and delays in rolling out vaccines.
It’s hardly surprising then that financial markets are increasingly looking past the current health crisis and positively re-rating companies like financials and real estate companies.
Global growth to come back strongly in 2021
The sharp rebound in economic growth in the second half of 2020 was mainly due to base effects (that is, because the first half was so poor) and massive fiscal support rather than the more elusive uptick in consumer spending.
The prospect of unleashing pent-up consumer demand as confidence returns, accompanied by low interest rates and further investment spend, could give global growth a significant boost this year. There have been early signs of a reversal of the significant under-performance of value shares relative to growth shares, and emerging economies relative to the US, and this trend could accelerate.
Confidence in South Africa to surprise on the upside
Investors betting that South African growth will continue to underwhelm expectations have been consistently correct for over a decade, and it’s easy based on the lack of urgency from government in implementing the necessary reforms to argue this will continue.
But given how low the expectations of future economic growth for the country now, if global growth exceeds expectations, it is possible that economic growth may finally surprise on the upside, especially as progress on fighting corruption and reforming state-owned enterprises may be further than jaded South African citizens are willing to acknowledge. South African bonds rallied late last year, but longer-term fund costs remain elevated and fundamental metrics remain stressed.
Global inflation to come back
Investors who have anticipated higher inflation since authorities first slashed interest rates in 2009 and embarked on massive quantitative easing have so far been disappointed, but this time around the stimulus is much higher, and financial markets are now tentatively starting to price in the possibility of higher inflation.
The price of US inflation-linked bonds in the accompanying graph shows investors (as in 2013) are once again prepared to hold them at a negative real yield. In contrast, inflation-linked bonds in South Africa still offer a sizeable real return given investor concern about our creditworthiness. What is important of course is whether the uptick in inflation is just due to base effects (that is, temporary) or far more disruptive. If inflation does gain traction (and it is still a big if) the extent to which it can be tolerated without a significant increase in short-term interest rates will determine how disruptive it will be.
Provided it remains relatively contained, higher inflation will help governments bring their nominal bond debt burdens to more sustainable levels, while holding inflation-linked bonds will offer some protection.
Decisive climate mitigating measures
The global economy has been unable to come close to meeting climate change objectives, even with much of the global economy under lockdown for part of 2020.
However, the concern that 2021 will be no different as countries ramp up their production to recover lost output could misjudge the intention to more radically shift away from the hydrocarbon economy. Investors are already moving capital to greener initiatives, and both the US through the new Biden administration and China through its next five-year plan might decisively move with Europe this year in committing to more ambitious goals.
The change of year gives us all an opportunity to step back from the noise and focus on the sensitivity of our investment portfolios to potential trends taking place in the world. We could be wrong about all five of these trends.
But being right about these trends is not the point; rather it forces one to think how resilient one’s investment strategy is to both a continuation and reversal of existing trends, and whether one is sufficiently diversified in the face of an unknown future.
David Crosoer and Professor Prieur du Plessis are chief investment officer of PPS Investments and chairperson of PPS Multi-Managers respectively; email: [email protected]
BUSINESS REPORT