It’s been quite the 12 month stretch, but as we look ahead to the second half of 2021, at least some of the uncertainty is behind us. We can quantify the economic effect of Covid-19 on businesses, we understand the risks ahead of us – delays to the vaccine rollout, new mutations – and vaccines present a potential solution to the problem.
However, that doesn’t necessarily guide people where to invest. As our economist friends at the IMF point out, there is still considerable uncertainty on the outlook. And if they’re uncertain – with all their economics degrees and all sorts - what chance does the average investor have?
Let’s consider what we do know. First, the outlook is reasonably good. The IMF folk have recently revised their expectations for global growth higher and it now sits at 6%. That’s punchy, but the estimates depend on the vaccine rollout going reasonably well, on governments maintaining their chunky spending programmes and on the absence of horrible Covid mutations putting the world back to square one.
It also means inflation not running out of control. William Davies, global head of equities at Threadneedle says all the money sloshing around from low interest rates and government spending programmes could see inflation expectations starting to pick up around the world as we go through this year.
He says we’ve all grown used to an environment where inflation is below 3%, but there is every chance it might rise higher. He adds: “There will be bottlenecks, plus there is enormous government stimulus and low interest rates. The key thing is whether it turns into more persistent inflation: Will it last into 2022 and 2023?”
This will affect the type of assets that do well. It may be slightly simplistic, but in general, if inflation is higher, that’s good news for companies geared to economic recovery – energy, financials, travel, discretionary spending. If it’s lower, that’s good for companies with safe, reliable long-term cash flows – technology and other high growth segments. Equally, weaker inflation in the West may flatter higher growth in the East. China’s 2021 GDP growth of 8.4% (https://www.imf.org/en/Publications/WEO/Issues/2021/03/23/world-economic-outlook-april-2021) starts to look pretty good in a lower growth environment, for example.
In terms of the type of fund managers will do well, in the short-term, a lower inflation environment may favour ‘value’ managers, such those at Schroders (Schroder Income or Recovery funds) or Jupiter (Jupiter UK Special Situations), while a lower inflation environment would see ‘growth’ managers such as Baillie Gifford resume their dominance. A middle ground option might be a fund group focused on quality, such as Aberdeen Standard (now ABRDN)
The performance of certain climate change-focused investments since the start of the year has shown that a great idea can make a poor investment if it gets too expensive. The iShares Global Climate Change ETF rose 132.8% in 2020, but has dropped 14.6% since the start of 2021 (source: Trustnet, to 27 April).
Nevertheless, there can be little doubt that sustainability has legs. Joe Biden’s $2 trillion infrastructure bill includes $174 billion to boost the electric vehicle market, $100 billion to update the country’s electric grid, plus billions for research and development. Europe’s Green Deal is worth around €1 trillion and, alongside climate action, targets biodiversity and reform of agriculture.
As such, investors can either wait for it to get cheaper, or approach it from a slightly different angle, whether that is green infrastructure, environmental technologies, renewable energy or biodiversity. Pretty much anywhere you look, there’s an ETF to fit the bill. There is also likely to be more emphasis this year on the ‘S’ in ESG. Social concerns have been exposed by the pandemic, and investors are increasingly concerned whether companies treat their staff properly, embrace diversity and manage their social responsibilities, so that’s an area to watch.
The UK has been a horrible place to be invested over the past five years. Uncertainty over Brexit and the sector make-up of the UK market have kept investors away. However, there are signs that it could revive. Simon Gergel, manager of the Merchant’s Investment trust says: “The UK economy looks like it will recover faster and UK equities are significantly cheaper because the UK has been very much out of favour...UK equities stand out at a time when almost every other asset class looks expensive.”
Smaller companies have already started doing well and it could be a fertile time for quality-focused smaller company managers such as Aberforth or the team at ABRDN. Either way, the UK should have a tailwind if it’s economy recovers faster than its global peers, as seems likely today.
Of course, this suggest a reversal in the long-term dominance of the US, where markets have been led higher by the mighty technology companies – Facebook, Apple, Microsoft and Google. Given its strong run over the past decade, many investors will be reluctant to let go of their S&P 500 tracker or other US investments. However, the US now faces a number of headwinds. Yes, stimulus is high, but this is being paid for out of corporate taxes. Recent strong earnings haven’t had much of an impact on share prices, suggesting a lot of good news is already in market valuations.
Finally, it is worth saying that the pandemic is likely to alter the landscape for investors in ways that are not yet expected. Some changes are clear – adoption of ecommerce, digitisation, agile working – but others may take time to evolve. Investors will need to be flexible as this ‘new normal’ emerges.
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