After huge upheaval and disruption in 2020, our head of markets assesses the chance of a revival in fortunes next year.
For many, 2020 will be a year best forgotten as the pattern of daily life was interrupted and, perhaps, in some ways changed forever.
Investors have had a similarly rough ride in the UK, although those exposed to the US market will have fared rather better. Even so, the question remains as to how 2021 might now look, and whether we can look forward to a year of recovery, in terms of -
Release of the UK from the EU
Online – accelerated structural shifts
The UK has been “uninvestable” according to a number of international institutional investors over recent times and much of this has been down to Brexit uncertainty.
Thus, the release of the UK from the EU removes a potential obstacle, even if the economic prospects make for ugly reading.
The finer implications of the exit will not emerge for months (and in some cases, years). However, there have more recently been some housebuilders and retailers keen to point out that their supply chains will see little effect, if any, where those are already sourced in the UK.
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The FTSE 100 has certainly had a chequered history of late. In 2017, the index added 7.6%, but in 2018 the decline was 12.5%. In 2019 it rose by 12.1% and, in 2020, at the time of writing, it has fallen by 16% (with much of the dividend attraction removed).
Interestingly, a spike of 14% since the end of October suggests that appetite for the index may slowly be turning more positive.
If a Covid -19 vaccine can be manufactured and distributed early, and if the conclusion of the Brexit talks result in an outcome which does not place undue further pressure on UK companies, and therefore the economy, the resultant effect would be positive. This would also lead to the question of whether investors, who are currently searching for value elsewhere globally, can be tempted back to the UK.
Previously beaten down sectors have seen something of a revival. The potential for stronger oil demand has improved the fortunes of the likes of BP (LSE:BP.) and Shell (LSE:RDSB), while British Airways owner International Consolidated Airlines (LSE:IAG) and Rolls-Royce (LSE:RR.) (who are paid on hours flown on their engines) have bounced on hopes of a lifeline for the tourist industry.
The dividend story could also be an attraction for investors in the event that we see a return to the previous average yield for the index of between 4% and 4.5%.
In addition, and on valuation grounds alone, the FTSE 100 looks cheap compared to many of its global peers.
Of course, none of this is guaranteed and, while the FTSE 100 is arguably overdue its day in the sun, the currently cloudy outlook needs first and foremost to clear significantly.
With central banks and governments still underpinning markets, to a large extent the roll-out of a pandemic vaccine is the last piece of the jigsaw to economic repair.
This could have many positive implications, such as for the banks.
Improved economic conditions could reduce the billions of pounds currently set aside for bad loans (impairments), which would inevitably boost balance sheets further and also provide a compelling case for a return to the payment of dividends.
Elsewhere, markets would expect stronger economic growth prospects to weigh on the US dollar.
A declining dollar can have a positive impact by loosening financial conditions, while making it cheaper for countries to service dollar-denominated debt. All things being equal, its inverse relationship with the oil price could be positive for the beleaguered black gold.
It also encourages investors to channel capital elsewhere, as the relative attractiveness of the currency wanes in favour of, for example, faster-growing economies where monetary tightening (higher interest rates) provide better potential returns.
The discord may have levelled off for the moment in the China/US relationship, but the issue has not gone away.
The fractious relationship was often exacerbated by the previous President. A mutually incompatible mistrust and suspicion over the use of technology in particular means that the relationship is in need of some repair.
It remains to be seen whether the new President will be more conciliatory, or whether the damage has been done both in terms of public opinion and some real sticking points, such as human rights.
The fact that the world’s two largest economies may remain at loggerheads could be unsettling for investors, and could accelerate the reversal of what had been a strong trend towards globalisation generally.
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As we emerge from the pandemic, it will begin to become evident how much of the enforced change to our behaviour is actually here to stay. It should also prove whether online has seen accelerated structural shifts.
This in turn will inform the progress of many companies.
Will the work from home culture continue, if only on a limited basis? This could further impact the likes of commercial property (especially in cities), residential property (less need to commute and therefore to live nearer a large city hub), and perhaps even socialising. If there is reticence to return to the habits of old, particularly in more crowded places, could there be a lasting impact on theatres, cinemas, pubs and restaurants?
Will holidays abroad feel the benefit of pent-up demand from a year of staycations, or will travellers be more circumspect until the pandemic all but vanishes globally?
And will business travel be severely crimped, given the ease with which meetings can be conducted online, as evidenced during the pandemic?
The welcome discovery of a vaccine in several countries and the likely acceptance of safety from the relevant regulators provided a boost to sentiment towards the end of this year.
Focus will shift in early 2021 towards the gap between discovery and distribution of the vaccine on a global scale.
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Not only would a roll-out in the early months be positive in crippling the pandemic, but it would also allow economies to regain some footing and companies to recoup some previously lost earnings.
Conversely, delays due to the regulatory bodies, doubts on the vaccine’s efficacy or a slower than expected distribution would threaten investor sentiment.
2020 has arguably been the year when the term “Environmental, Social and Governance”, or ESG, really came of age.
Next year is likely to see ESG becoming fully entrenched, rather than a separate animal, in investment terms.
Some of the detail remains to be ironed out, such as the very definition of “ethical” and “social”, and with companies and asset managers responding to claims of greenwashing, or exaggerating their commitment to the practice. The pandemic has provided further focus, with factors such as employee safety continuing to grab headlines.
“Governance” has arguably long been core to the running of successful companies. However, the increasing use of separate ESG disclosures and actions being taken within company accounts should move the topic even nearer to centre stage next year. Investors are increasingly requiring their returns not only to be profitable, but also responsible.
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Markets do not move up in a straight line, and investment brings risks by definition. 2021 will be no exception, and investors will need to consider some of the more likely possibilities.
“Big tech” companies in the US have had a market-leading year, propelled by the change to working practices and the exaggerated move towards all things online.
However, in the US, concerns over certain monopolistic power and even abuse of their dominance has caught the eye of the regulators. With ongoing cases on monies paid (or not) in other tax jurisdictions, next year could prove to be pivotal in how big tech is treated. Perhaps less likely but a cause of some debate, enforced data-sharing or even company break-ups may be on the table.
There is another risk in the form of withdrawing monetary stimulus too soon, or indeed not providing more where required. Economic recovery could be fragile, especially in those sectors most affected by Covid-19, and the balancing act needs to be carefully managed.
The pandemic has also shone a light on supply chain disruption, and political thinking has tended towards “de-globalisation” over the last few years. If this were to play out, it raises the possibility of higher production costs and in turn inflation, as short-term cost efficiency is partly sacrificed for long-term reliability.
Year-on-year comparisons for companies reporting will be interesting to watch and perhaps can be loosely summarised as follows.
The first quarter of 2020 was partly affected by the pandemic in the month of March, with January and February having been reasonably strong months. By the same token, it is unlikely that companies will have been able to recover by the first quarter of 2021 and comparisons will therefore be less positive.
With the possibility of a vaccine in place at some point during the second quarter of 2021, and compared to Q2 2020 when the market was taking the brunt of the pandemic pain, this could be a much stronger comparative quarter.
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The third quarter could be tougher, since Q3 2020 was starting to see the benefits of stimulus and a nascent recovery. Much will therefore depend on the strength of the economies at that point.
With the second wave currently having a further economic impact and with some stimulus packages dropping away, Q4 2021 should compare favourably with the final quarter of this year.
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