Market Update January 2021
A new economic cycle
When we look at where we are currently in the economic cycle, we hold the view that we are now beginning a completely new cycle.
Last year was very challenging one with a Global recession. This recession was however very short lived as the levels of support provided from a fiscal and monetary perspective were enormous. These supports are likely to remain in place and there continues to be high levels of pent up demand out there. We saw this when economies reopened last year (before subsequent lockdowns) and growth surged. While the labour market has taken a huge hit, the levels of income support have equally been huge. In Ireland disposable income rose last year despite the levels of unemployment and if you look at the income tax paid here last year it was only down about 1%, which is an incredible number when we think of the hit to our labour market.
There is a huge buffer amongst consumers, who have put a lot of Cash on Deposit. Levels of deposits here are up to a record level of €123billion. In the U.S. the amount of money in money market funds is running at about $4.5trillion, typically this figure is at about $2.5trillion. We think when we turn the corner and when economies reopen again a lot of this excess Cash is there to be spent and potentially to come into equity markets.
The Vaccine Roll Out
The vaccines have been a gamechanger for the Global economy. The case number, deaths and hospitalisations globally are now appalling. If we had seen these numbers six or nine months ago then equity markets would likely be significantly lower. The reason they are continuing to rise is there is a real belief that the vaccines will work and when a large portion of the population is vaccinated, we will be able to reopen economies again and hopefully this will be the last lockdown we have to go through. With this anticipation many analysists are predicting a big surge in growth coming through and positive equity markets.
There has been a slower rollout of the vaccines than people had expected, everywhere. There are exceptions, Israel has over 30% of the population already vaccinated in the space of 4 weeks so this shows us that if the right structures are in place Governments can do it properly and get it done quickly. Israel has a population of 8.5 million so it’s not a small country, they are doing it and doing it well. The U.K. has suddenly picked up over the last week or two because the AstraZeneca vaccine has become available. The U.K. had been in line with the rest of Europe and the US running at about 1% of their population vaccinated but they are now up to about 7% already. President Biden in the US has continued to emphasise that he wants structures in place so that the vaccines are not just being produced, they are being used and given to people.
We have 3 vaccines approved, and announcements are due from Johnson & Johnson and Novavax by the end of this quarter. With the right structures being put in place we do think you will get to the point whereby at the end of this quarter there will be a real sense that we can reopen again without necessarily going back to these restrictive lockdowns. Governments are trying to target the vulnerable age groups and frontline workers to take the pressure off the hospital systems. Looking at the rate of vaccinations currently, if these continue through the first quarter, by April experts are suggesting that in the U.S. the numbers in hospital due to Covid will halve and in the UK, it will be down by 75%. Their view is that we do not have to get 60% of the population vaccinated by March or April, all you must do is get the right groups vaccinated so that the pressure is taken off the hospital systems and that’s where they are going at the moment. Whilst the number of vaccinations may not be as big as people had hoped for, they are going in the right direction and once the pressure is off the healthcare and hospital systems economies can reopen.
Where is the Global Economy?
The 1st quarter of 2021 will be very difficult in terms of the economic figures. Europe is probably going to be in recession again this quarter, the U.K. could be in recession as well this quarter. Globally growth will only be around 1.5%-2.0% this quarter but into the middle of the year, as we reopen, we do think you will get growth picking up substantially. Some experts are predicting it could be between 8%-10% on an annualised basis. Consumption will pick up and equity markets should do well. We hold the view that the growth outlook is positive and then looking into next year as well, growth will slow albeit to reasonable levels of perhaps 4%-5%. Looking into next year as these stimulus measures remain in place for much of this year, analysists are predicting growth next year of about 4.5% in the global economy. At the moment we are going through a very difficult quarter, this is the slowest quarter we have had since we came out of recession in May last year, but equity markets are looking through it and focusing on what the vaccinations will be able to do and what growth will be through the middle of the year and beyond.
Typically, as you come out of recession and go into a new cycle, there are different phases of that growth cycle. The first phase is Recovery Phase which we had from May last year to December and markets did very well. Markets are up 60% from the lows, they have done very well. As we move into the Growth Phase, which is where we are now, we believe, that growth will pick up as we go through this year, with equity markets still doing very well, possibly not as well as they did previously but they still should to do quite well.
When we look at valuations for equity markets, they do look expensive no matter what metric we look at – price to earnings, dividend yield, price to book. However, they continue to look very cheap versus bonds, because of how low bond yields are.
We are of the view that the main positive fundamental backdrop to higher equity valuations is that earnings are going to be quite strong. We could see 25% earnings growth this year alone and possibly 16% next year. Typically, when we see the economy growing and earnings growing it would be very unusual to see equity markets down and not doing well in that type of environment. From a fiscal perspective the US had a substantial $900billion package at the end of last year. There is now talk with the Democrats having won the two seats in the Senate in Georgia will now produce another fiscal package in the region of $1.9trillion. Because the numbers are so tight in the Senate, we don’t think the Democrats will get $1.9trillion through but they could get a $1trillion package through so with those two packages combined it would be almost $2trillion, about 12% of U.S. GDP.
Over the last two weeks growth forecast for this year in the US have gone from 3.5% to 5.5%, on the back of these two fiscal packages. Growth forecasts for the global economy have gone from 5% to 6% in the last two weeks. Despite the weak backdrop for this quarter which has been revised down, what we have seen is the forecast for the entire year revised upward because of these fiscal supports and the hopes around the vaccine.
The US Federal Reserve (FED) is saying they will not raise interest rates until at least the end of 2023. Equity markets think it will be 2024/2025 before they raise rates. The European Central Bank (ECB) is not going to raise rates for about 4.5 years. They FED and ECB have both committed to continuing with Quantitative Easing or their asset purchases programme through at least 2021 if not longer. These fiscal and monetary supports will remain in place and the authorities are committing to keep these there until they are confident that the recovery has really taken hold.
Very short term, given that equity markets are up 20% from where we were at the end of October, if some negative news comes through, we wouldn’t be surprised if there was a modest 3% - 5% pull back in equities short term but we see these every year. On average there is a 3 - 5% pull backs in the market every year so we would not be surprised to see one at some point over the next 4-6 weeks. We do think it will be a short-term correction so there should be no need to panic!
Looking though the year as a whole we are of the view that there is a reasonable level of upside in the equity market and looking into next year, if we are at the beginning of a new economic cycle, there’s reasonable levels of positive returns to be expected in the markets over the next couple of years.