After a potentially challenging winter subject to further waves of coronavirus, we anticipate a strong global economic recovery in 2021. We expect this to be driven by further positive vaccine news as well as continued support from both central bankers and politicians. Equity and credit markets could move higher, and the dollar and other perceived safe haven assets weaken. We expect inflation to remain contained.
Here we summarise our outlook for the global economy and look at other themes we are thinking about, including potential risks that lie ahead, to help illustrate how we are positioning portfolios as we move into the new year.
The near term economic outlook
There is light at the end of the tunnel. Progress on the vaccine should, eventually, bring a return to normal social behaviour and end the restrictions which remain in place in many parts of the world today.
The distribution of a vaccine resulting in sufficient immunity should allow for stronger economic activity during the second half of 2021. Persistently loose monetary policy and supportive fiscal measures while activity normalises could see this recovery carry on into 2022, resulting in above trend growth over the next couple of years - as reflected in the forecasts below.
Meanwhile inflation is likely to remain contained in the near term with only a slight pick up in response to a recovery in the oil price. Over the medium term we do see inflationary pressures building, given the acceleration in money supply (see below) combined with the potential effects of excess demand from our anticipated above-trend growth.
We know higher inflation poses challenges to investors, but we do not see significant threats in the short term.
The factors that will drive inflation - or deflation
The liquidity safety net
The response of both central banks and governments to the pandemic has been remarkable in its speed and scale. The Bank of England recently announced a further £150bn of quantitative easing, bringing the total to nearly £900bn. Meanwhile the Federal Reserve is on course to expand its balance sheet to $9 trillion by 2022. Alongside this, the US government is likely to run a $4 trillion deficit this year, whilst in the UK we look likely to run a £350 billion deficit for the year which will take debt through £2 trillion.
From a financial market perspective the support provided by low or negative interest rates and abundant fiscal spend has been one of the key themes of 2020. Investors are understandably concerned that a reversal of policy and withdrawal of support may hurt equity markets in 2021.
While the massive increase in fiscal spend this year was initially a reaction to a unique set of circumstances and was likely intended to be temporary, we expect further fiscal spend in 2021, in the US and elsewhere. As we move past Covid-19 we see the potential for fiscal spend to remain elevated in comparison to pre-2020 levels, with government spending shifting to focus on projects such as infrastructure build or green initiatives.
The Green agenda and energy transition
The challenge of climate change is well known. At the Paris Agreement in 2015, countries pledged to reduce their emissions to prevent an increase in temperatures above pre-industrial revolution levels of 2ºC. Since then, the Intergovernmental Panel on Climate Change (IPCC) has released a special report evidencing the benefits of a further reduction to 1.5ºC, which most governments have now accepted.
To achieve these targets, global emissions must fall by 33% from 2010 levels by 2030, a goal that will require significant levels of public and private sector investment. When you consider that 73% of global CO2 emissions come from energy (including fossil fuel consumption, electricity, buildings, transport and industry), it is not unreasonable to assume that a significant proportion of this investment will be focused in these areas, with expectations that over the next 15 years global governments will invest $30 trillion on green infrastructure projects.
Two conclusions can be drawn from this. Firstly, energy transition represents a significant long term investment opportunity as we see a shift in global primary energy use towards renewables. This will not simply be in renewable energy companies (which will clearly benefit), but also in the green infrastructure needed to facilitate the transition, be it new grid connections, or charging points for electric vehicles.
Secondly, it presents politicians eager to continue to support the economy through ongoing fiscal spend with an opportunity to do so. We are already starting to see this, with plans for a third of the EU’s €1.8 trillion recovery plan being made available for green transition; with the announcement of China’s $550bn package for low-carbon transport and infrastructure, or with Biden’s proposed $2 trillion climate plan to finance a 100% clean US economy by 2050.
As we move through 2021 and the economic challenges of Covid-19 start to wane, it may be the case that green initiatives work their way further up the political agenda and help facilitate the ongoing economic safety net of elevated government spending.
One outcome of the pandemic has been the acceleration of existing trends which we believe will reshape our daily lives and the investment landscape. Disruption to business models has been brought forward as consumer habits have been forced to change as a result of restrictions on movement. Just compare the fortunes of established high street names such as Debenhams and Topshop with online giant Amazon, whose share price is now up close to 70%1 year to date.
In a similar vein the events of this year have furthered the shift to a less global economy. The disruption of global supply chains in the first quarter highlighted the benefits of at least diversifying, or fully localising, supply chains. Separately, widening wealth inequality fuelling populist politics has seen further protectionism and economic de-coupling of global powers.
This trend may have meaningful implications for large cap companies which have built up global supply chains. If we see a trend towards localisation, these advantages may unwind. Furthermore, corporate tax increases may well be round the corner – as is the potential for greater regulation in some industries – as political leaders respond to populism.
Conversely, small companies will likely find it easier to adapt. They are not burdened by the scale of investment in global supply chains as are large companies, and they have more options to source locally. Of course, large companies can adapt and restructure. This may give rise to an interesting long term investment opportunity as automation and robotics increasingly replaces human capital
These trends will take time to develop, but with only 35% of global companies having made moves to localise their business models2, we might expect to hear more about this in the year ahead.
Vaccine-led recovery supportive for cyclical assets
2020 has been a year of winners and losers. A unique set of circumstances forcing changes to working, social and shopping practices have favoured a handful of industries predominantly within the technology sector, while others have faltered under the economic uncertainty. The latter have tended to be industries with greater economic sensitivity such as oil, gas and financials, or those which were effectively shut down by the pandemic – such as hotels, restaurants and leisure enterprises.
News of the vaccine breakthrough proved a catalyst for many investors to consider economic recovery in 2021 and the potential for earnings growth in many of the unloved areas of the market. We have seen a period of improved performance in these industries.
We have not lost conviction in those sectors such as technology which have done well this year. We continue to see high rates of long term revenue and earnings growth, as well as ongoing opportunities for disruption of traditional business models in an increasingly digital world. Technology will continue to offer investment opportunities in the years to come. But we expect the market recovery to broaden out over a wider range of sectors, presenting opportunities in areas which still have ground to make up after a challenging year.
We are not out of the woods yet
Despite the positivity surrounding the roll-out of vaccines, Covid-19 remains a worrying threat. A fast-spreading new strain of the virus in the UK has led to renewed restrictions, which could be required in other countries. The last few weeks have been a reminder that economic recovery, and a return to relative normality, are unlikely to be smooth.
Global equity markets enjoyed a strong finish to 2020, valuations are far from cheap and investor sentiment has significantly improved in recent months. It would therefore appear that a lot of the good news has already been priced in.
Democrats win Georgia
Following a close run-off race in Georgia, the Democrats will have a slim majority in the Senate. This will certainly increase Biden's scope to enact his legislative agenda, though the small size of the majority means he may still be relatively constrained.
Even so, the Democrats' success could have a number of implications which test investor sentiment. We could see the corporate tax rate rise to 28%, reducing S&P earnings by some 10%. Stricter drug pricing policies could affect the US healthcare system, whilst the tech sector could come under greater scrutiny with the potential for more stringent regulation. Whilst this is unlikely to meaningfully change the longer term outlook for the US market, or healthcare and tech specifically, it would cause some shorter term volatility.
The trial results for the range of Covid vaccines have been positive, but there are unanswered questions. We do not know how vaccines will cope with new strains of the virus. Some governments are also struggling with the challenge of vaccine distribution. This will likely be even more of an issue in emerging markets.
Furthermore, there is a chance that a large number may not want to take the vaccine. If there isn’t sufficient take up we may not reach levels of immunity to allow for restrictions to be fully lifted, impacting the pace of the recovery.
Global equity market valuations have re-rated from March lows, helping to drive returns this year. Whilst 2021 earnings expectations are robust and help support elevated valuations, if current restrictions result in earnings disappointments, investors could start to re-assess these assumptions. Investors may be willing to look through the short term uncertainty and focus once more on liquidity support. Nevertheless, we may well see elevated volatility as a result.
In this environment, while we are constructive on risk assets for the year ahead, we feel that maintaining an allocation to defensive assets in the form of government bonds, gold and cash is prudent to help mitigate against periods of volatility over the coming months.
 Source: Bloomberg. Performance in GBP terms to 4 December
 Deutsche Bank Research "Can big companies survive localisation?" – October 2020
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