Global Growth and Opportunities in 2021

Key Takeaways

Francis Scotland, Director, Global Macro Research, Brandywine Global

Global Fixed Income

• Global trade was expected to reflate post 2019, helped by an easing Fed, China stimulus and a U.S. /China trade deal. However, COVID-19 caused the global economy to collapse in early 2020. We then experienced a V-shaped recovery on extra-ordinary monetary and fiscal policy support and the expectation of learning to live with and overcoming the disease. We see the inflection point arriving as vaccines allow re-opening of the global service sectors.
• The lagged effect of accommodative policies and central banks who are willing to tolerate higher inflation, mean that global growth is likely to surprise to the upside in 2021/22.
• Policy measures and the ability for the market to adapt to this environment sets the stage for a reflationary environment, with potential inflationary risks as the vaccine success manifests in reopening of the service sector, rapid job hires, and improved consumer confidence.
• Reflation carries duration risk for U.S. Treasuries. Additionally, if the vaccine is successful quickly, there could be a certain amount of volatility associated with the pace of the rise in yields and curve steepening. However, reflation also implies reduced defaults and spread compression across Emerging Markets and high yield.
• As a result, markets could be faced with a shift in policy conditions (tightening) earlier than expected. As an example, China was first to recover and is already ahead of the developed world by 6-9 months. Consequently, yields have normalised and policy is throttling back on stimulus.  

Discussion Insights

When should we expect higher interest rates?

• Rates have already started moving up in China as the economy has stabilized after numerous efforts. The 10 Year China Government Bond is now higher than it was before the pandemic.
• For U.S. Treasury Bonds to finish 60 basis points higher than they are currently to me is not a reason for the Fed to think about engaging in yield curve control.
• If there is a magic bullet and suddenly the virus drops off the planet, the expenditure of trillions of dollars of savings that are accumulating in households could lead to a very disruptive move in the fixed income market, which could also trigger a disruptive move in the currency market. In those circumstances, the Fed could be expected to intervene to try to smooth things out.
• That aside, I have never seen a central bank encourage market frenzy by giving such strong forward guidance and there is a chance that the Fed, the IMF, the World Bank are all behind the curve.
• I am more concerned about what happens when things get so good that the Fed gives us a “surprise” and starts slowing things down a little bit.

What are key geopolitical issues on your mind?

• China/U.S. relations and populism are two political risks I am concerned about.
• The number one geopolitical issue was U.S./China relations with the main issue being America's unwillingness to trade with China because the U.S. believed China gamed the trading rules of the World Trade Organization. The Trump administration was very successful in getting bipartisan support around that view.
• While there was political dysfunction playing out in Washington, China has effectively used this pandemic to bolster its position, where it has effectively taken over Hong Kong 20 years ahead of schedule, negotiated an investment deal with Europe, and negotiated a regional trade bloc, which includes some of America's allies. All this in an effort to minimise what is going to be a more multilateral effort from the Biden administration.
• Another geopolitical factor, which shows up in different places, in different ways, is populism.
• In the United States, inequality of income and wealth distribution is one of the main factors behind this surge in populism.
• The U.S. now have an administration that has an opportunity to do something about it in their way.
• By lining up a socialistic type of set of policies such as an enormous pandemic support, a multi-trillion-dollar energy infrastructure program and a tax-redistribution plan, the new administration is focussed on redressing this income imbalance and taking advantage of the desire for cleaner energy.
• What then happens beyond the strong growth in the next couple of years? What are the longer-term implications of this “re-distributionist” tax policy? Could this be an inefficient allocation of capital? These are questions investors should think about.

Where do you see opportunities in global fixed income now?

• Information risks lie in the direction of stronger growth than the view reflected in low Treasury yields, which signals an underweight or short exposure to U.S. Treasuries.
• Against a backdrop of a reflationary environment, we favour commodity sensitive sovereign markets and a bias to increase beta to cyclical corporates.
• Currency markets signal greater opportunities with a tailwind for the U.S. dollar which favours the EM FX complex.

Stephen Dover, Executive Vice President, Head Of Equities, Franklin Templeton

Global Equity

• In spite of the unevenness of the vaccine rollout globally, the magnitude and efficiency should pick up over the next few months. The schedule of COVID vaccinations will most likely impact the pace and breadth of economic recovery both in the U.S. and globally.
• Low interest rates for longer and significant stimulus are supportive of risk assets. Monetary and fiscal stimulus are the primary drivers of liquidity globally. The combined measures should contribute in large part to the upcoming growth across major regions. A byproduct of this liquidity is that corporations have record amount of cash on their balance sheets while taking on debt to buy back shares.
• Equities are likely to outperform as earnings expectations in major regions for 2021 are a lot higher than it was for 2020. On that front, we think that earnings multiples are reasonable based on history, bond alternatives and earnings growth.
• We see opportunities in global markets and value stocks. Value has reached a discount against growth we have not seen since 2000. Historically, value stocks have outperformed for an extended period after a discount of this magnitude. In addition, we see from past experiences that, a weak U.S. dollar is good for international stocks. In particular, Emerging Markets, where the composition of indices are reflecting the new economy and growth, while complementing its existing exports driven and commodity heavy capabilities.
• Investors could also explore “Green” opportunities as governments in both the U.S. and Europe have either already poured money into that or is planning to. Stocks that are tilted towards the ESG space will also be favored amongst institutions as mandates get stricter on climate issues. On the governance front, regulatory reform that is more shareholder friendly could present opportunities in Japan. Japanese corporations are cleaning up their balance sheets and as a testament of their balance sheet strength, Japanese companies barely had any cuts in dividend payments, unlike the rest of the developed world.

Discussion insights

Are current equity valuations stretched?

• If we have gradual growth equity markets still have the capacity to absorb that. In fact, it could be quite positive for emerging markets as pent-up savings goes back into consumption and hopefully that will fall over into earnings per share and help companies grow. I think that just looking at the Price to Earnings ratio is a poor indicator of whether the market is over or under valued, primarily because of low interest rates and pandemic-induced artificially deflated earnings. In addition, relative to value stocks, growth stocks have risen a lot over the last few years, which could reverse as the economy picks up.

Are Emerging Market equities attractive?

• Yes, in particular the Chinese equity market is attractive because China is so different from the rest of the world and less dependent. Also, Emerging Markets is a diversity play if nothing else. If global stimulus does indeed lead to an economic boom it is going to be quite positive for emerging markets, which have underperformed significantly over the last few years. From an exports perspective, EM economies will also stand to benefit from the production and exports materials and commodities.
   

What are key geopolitical issues on your mind?

• U.S./China relations is a key issue. With the new administration, I think that the approach to China will probably change to try to be more of a diplomatic approach and to try to have the United States work with all of its allies. I think China itself has an opportunity this year and over the course of the next couple of years, to be a soft power globally. I think the very specific thing is that probably we will not have as many headlines around trade as we have in the last four years.

Where do you see risks to global equities?

• It is an interesting risk profile we have now within equity markets, because there is some risk of equity markets really outperforming over this period of time. So, there is an upside risk, but there is also tied within that a risk whenever we see that of a bubble that can pop really quickly, and there is probably something out there that we are not aware of that can prick a bubble.
• Companies who are labelling themselves as “green” have to prove that earnings does follow the multiple expansion. These companies have appreciated because there is quite a bit of demand for them especially from pensions who have put more emphasis on ESG in recent years. Their scarcity will continue to inflate demand and could lead to price vulnerability over a period of time.
• Overall, I do think there is a lot of opportunities globally and that there could be some more balance coming back into the market. And that is really the case for looking at companies outside of the United States and looking at maybe for value versus growth. There has been such an imbalance over the last couple of years that a reversion is likely.