2021 investment outlook (Sponsored)

Feb 09, 2021
Ian Slattery, Investment Consultant at Zurich Life, explains why a turbulent year for investment markets does not necessarily mean a negative outcome for pension investors.

With 2020 now firmly in the rear-view mirror, it is an opportune time to take stock of investment markets in a year that was truly remarkable in every sense. 2020 began ominously, with geopolitical tensions between the US and Iran at an all-time high. Simultaneously, a watching world was gripped by images of devastating bushfires in Australia. What was to follow cemented the year’s reputation in modern history and is near impossible to summarise in just a paragraph. In the US alone, we had a presidential impeachment, a raging pandemic, the largest protests in history, a disputed presidential election, and a global stock market up nearly 7% for the year after a historic collapse in the spring. With that in mind, it is worth reviewing the year just gone and looking to the year ahead to better understand how global events may not have impacted your company pension in the way you expected.

Equities enjoyed a strong start to 2020 and were up over 7% for the first seven weeks. However, what followed was the fastest bear market in history as stocks took just 16 trading days to fall 20%. Ultimately, it ended down 34% over a four-week period driven predominately by concerns relating to the COVID-19 pandemic. Subsequently, stocks enjoyed a stellar second quarter in 2020 with the US market seeing its best 50 days in history. Over the summer, returns were more muted as investors reflected on and digested the large moves seen in the first half of the year. A strengthening euro currency, which reduces returns in overseas assets, also proved to be a headwind as markets fell in September and October. However, November proved to be a stellar month for equities as optimism was stoked by the US election results and the emergence of several viable vaccines. The optimism continued through December, and global markets finished the year with a positive return of 7%.

In 2020, markets were led by the influential US stock market, which is the largest in the world. Sector divergence has been a key theme in markets this year with the likes of technology (+32%) and consumer discretionary (+26%) massively outperforming sectors such as real estate (-12%) and energy (-36%).

In terms of monetary policy, the Federal Reserve cut its policy rate by 1.5% in March to the 0%-0.25% range and has recently announced a change in its inflation targeting, which is likely to keep rates unchanged for the foreseeable future. The focus within the US economy has turned toward fiscal or government spending. The European Central Bank cut interest rates at its September 2019 meeting to -0.5% and has not moved since. However, in response to the pandemic, it announced a Pandemic Emergency Purchase Programme, which is helping to contain peripheral sovereign bond spreads. This programme was expanded by a further €600 billion initially and extended into 2022 at the December meeting. Eurozone bonds performed well throughout the period, particularly as the COVID-19 pandemic unfolded. Unprecedented monetary stimulus kept eurozone yields at rock bottom levels.

Commodities and currencies endured a rollercoaster ride as gold and several ‘safe-haven’ currencies saw significant price appreciation at the height of the crisis. However, this trend reversed as investor confidence returned. The price of oil collapsed in the early months of the year on fears of drastically reduced demand due to the COVID-19 outbreak, combined with a spat between Russia and Saudi Arabia over supply. Within a very unusual trading environment, oil futures moved to a deeply negative value at one point.

Policymaker support, including lower interest rates and rapid fiscal response, have contributed to the swift economic recovery. However, it is worth noting that GDP figures have yet to recapture previous highs, and there has been much volatility and divergence in performance across asset classes.

Looking to the year ahead, equities and corporate bonds continue to be our preferred asset classes versus government bonds and cash. The policy of the major global central banks remains loose, both in terms of interest rates and asset purchase programmes. The fiscal response in the eurozone, via the COVID-19 recovery package, is impressive in terms of its scope and further fiscal stimulus from the US has emerged. Overall, the policy backdrop for investment markets remains supportive.

figure-1-bull-v-bears

Global growth appears to have bottomed out in the second quarter of 2020 and has recovered since then. However, the full effect of winter lockdowns, particularly in Europe, are not yet clear. Business activity, as measured by PMI (Purchasing Managers’ Index) data, has recovered but not entirely. Similarly, the initial recovery in the jobs market has stalled somewhat. It may be some time until the full effects of COVID-19 (and the associated evolution of the economy) are clear. While lockdowns in the developed world have hit some sectors harder than others, consumers are generally well-positioned. That sentiment is supported by elevated savings rates, some evidence of pent-up demand, and a buoyant US housing market fuelled by cheaper credit. The transition to a full reopening of the economy and the subsequent positive impact on economic growth is somewhat dependent on the timelines and logistics of a vaccine rollout.

Equity valuations do look expensive versus history. However, the relative valuation thesis versus other asset classes remains compelling. At this point in the economic cycle, equities continue to offer the best opportunity for positive returns, irrespective of absolute valuation levels. Growth is returning, the backdrop is positive, and the lower interest rate environment profoundly affects valuations across investment markets.
Conversely, we remain cautious in our outlook on eurozone sovereign debt. The low level of rates continues to make long-term return prospects unattractive. Inflation expectations remain muted and are not at the desired level for global central bankers. Therefore, policy is to remain loose. With this in mind, a large spike in interest rates and subsequently bond yields is not envisaged. However, the growing government debt levels may well be a cause for concern later in the cycle.

In terms of other risks, the suppression of the COVID-19 virus still needs to be implemented. A further resurgence in cases, or missteps in the logistical rollouts of vaccines, have the potential to derail the recovery. The new US administration faces numerous challenges, both domestically and abroad. Strained relationships with China and the EU are still very evident. Finally, given the scale of policy intervention seen in 2020, a misstep or premature withdrawal in supports could hit sentiment and ultimately affect the performance of risk assets. With this in mind, we maintain a flexible approach to asset allocation as volatility (as measured by the Volatility Index) and somewhat conversely, investor sentimfigent, both remain elevated.

In conclusion, 2020 was a volatile year – but not a negative one for pension investors. Despite the rollercoaster ride in 2020, there are no guarantees that 2021 will be benign for markets. Already we see increased COVID-19 case numbers, issues with vaccine rollouts, and enduring political strife over the US election. However, for those saving for retirement through their company pension, sticking to your long-term goals, continuing your pension contributions, and having an investment manager that can outperform are investment principles that will stand the test of time.

Source: Zurich Life, January 2021. For more information, visit www.zurich.ie. Zurich Life
 Assurance plc is regulated by the Central Bank of Ireland.

This article is sponsored by Zurich Life.