This time last year, investors began 2020 in a generally positive frame of mind and outlook. Despite all the market expectations and forecasts for 2020, most pundits – if not all – could hardly have imagined the unprecedented, extent and dramatic nature of the socio-economic and market environment that would ensue and prevail globally.
Indeed 2020 could be labelled a “black swan” year (a metaphor describing an event which is unanticipated, but which has very far-reaching consequences).
In March 2020 the World Health Organisation announced the Covid-19 virus outbreak a global health emergency and soon afterwards declared it a global pandemic. What followed was a turn of events so unforeseen that many never considered or believed that humanity would experience and suffer through a pandemic on a worldwide scale. In the modern mind, this was not to happen in our lifetime at least; in the past yes, and perhaps some time in future. But it did happen, and all very suddenly.
Hoping that the virus would be contained geographically after the initial outbreak in China, it however spread like wildfire throughout the world. Very little could have prepared us for the abrupt, deep impact and extent of the halt to economic activity across the world around the same time early in 2020.
And so indeed 2020 will be remembered as a year overwhelmingly dominated and impacted by the coronavirus pandemic.
Its onset smashed all 2020 economic and financial market predictions sending pundits back to their drawing boards and “crystal balls” in endeavours to somehow re-divine the future.
Governments were compelled to lock down their economies and impose many restrictions and measures necessary – such as social distancing and wearing of masks – in efforts to curb the spread of the virus while readying health systems to cope with its medical consequences. During the closing weeks of December 2020 around 78 million coronavirus cases had been reported with, tragically, over 1.7 million deaths registered and counting.
The first wave of the virus earlier in the year sparked a financial market crash wiping off trillions in value in one of the greatest meltdowns of all time in terms of magnitude and speed.
Furthermore, it triggered recessions around the globe given the economic devastation of lockdowns and restrictions; business and consumer confidence slumped, oil prices collapsed to ultra-low levels (even negative), travel and human mobility abruptly ceased and unemployment soared. Global GDP in the second quarter of the year had been negatively impacted to the tune of around USD10 trillion. The services sector has been impacted particularly severely, given its nature of engaging and dealing with people having been the major growth component of job creation in the modern era.
Monetary and fiscal policy measures
The socio-economic and market impact and consequences of the virus prompted a massive wave of unprecedented monetary and fiscal policy measures around the globe. Governments had to swiftly act and implement significant emergency lifelines to protect people and businesses in response to the pandemic. Central banks acted by providing more quantitative easing (QE) and keeping monetary policy conditions ultra-easy. These supportive measures have been significantly larger than during the Global Financial Crisis (GFC) of 2007/2008.
The massive policy interventions by governments and central banks, especially of major economies, led to a powerful and equally sharp rebound in markets post its dramatic collapse. The rally, off its lows, has been reckoned to have surpassed the greatest rallies of the past century. On the back of these substantial policy measures and the easing of restrictions into the third quarter as the initial virus wave subsided, many economies staged a strong upturn in the third quarter relative to the depressed levels of the second quarter.
At this point in time the US, Europe and several other countries (including South Africa) have been hit with a resurgence of the virus and are experiencing second waves. The coronavirus is spreading faster than before despite restrictive measures which are in place. To compound the situation, mutations of the virus have lately been identified which make it more infectious and pose further challenges to combatting and bringing the pandemic under control.
There is no doubt that the second wave, and the risk of virus variants, will have a negative impact on global economic activity until it is brought under control via renewed restrictions and successful vaccinations. Social restrictions will likely remain in place long after vaccine distribution begins. Sustained economic disruption and/or underwhelming vaccine effectiveness into 2021 would endanger the widely anticipated strong global recovery into the second half of the year.
The latest developments will heighten the commitment of authorities in supporting economies indefinitely, maintaining easy monetary and reflationary policies, and potentially boost fiscal policy measures until such time that economies have healed and are on a more sustainable trajectory. Whether the latter will be obtained without the need for sustained and continued emergency type policy measures, remains more of a hope than anything else, judged by the policy path since the GFC.
Fast forward to January 2021
With amazing speed, multiple Covid-19 vaccines have been in development, becoming available towards the end of 2020. Market spirits have been boosted by the realisation that the roll-out of these vaccines is occurring much sooner than previously expected. By all counts, 2021 will most likely be a year of the vaccine. In particular, ample liquidity being provided to the global economy by the world’s major central banks, together with optimism related to the roll-out of Covid-19 vaccines and the election victory of Joe Biden as US president, have been helping to sustain the positive sentiment in global financial markets. The favourable sentiment has been a factor in the flow of funds into emerging markets, dollar weakness and the well touted value rotation play by stock market participants.
The market appears to be in a self-perpetuating upward cycle, defying the pandemic and accompanying economic woes. However, low interest rates in less risky investments such as money markets and government bonds do not offer attractive yields and general expectations of inflation imply risk to prices. Low interest rates combined with expectations of continued central bank and likely fiscal backing and support are encouraging investors to seek returns in riskier assets.
With these underpins to market sentiment and considering the positive economic expectations for later in the year assuming successful vaccine roll-outs, investors are betting that the market’s positive momentum would continue in 2021.
Despite the significant market rally off its lows in the second quarter of 2020, a continuing global health pandemic and near-term economic uncertainty coupled with potential for double dip recessions in some parts of the world, the general outlook for 2021 is one of optimism – for both the economy and a continued stock market rally given the promise of vaccinations. It is believed that effective vaccine rollouts will turn the tide against the pandemic allowing economic actors to look through any virus developments for various outcomes such as:
- A rebound and synchronised global (and emerging market [EM]) growth by the second half of 2021 with stronger EM growth supporting EM equity outperformance (especially as flows to EM return after many years);
- Continued dollar weakness;
- Ultra-loose and supportive monetary policy;
- Ongoing hunt for yield;
- Hope of continued, and possibly increasing, fiscal support; and
- Reduced geopolitical and trade tensions / risks under a Biden administration.
What are some possible risks over the near term?
- Covid-19 uncertainty and variants;
- Economic slowdown and lofty equity valuations;
- Increasing levels of debt;
- Premature fiscal tightening; and
- Another black swan.
While the economy may do better assuming an effective and successful vaccine roll-out, the market has been discounting a lot of good news with some major market valuations at steep levels. Further, a number of market sentiment indicators have flashed red lately.
While sentiment on a look-through basis may drive positive market momentum longer term given optimism of a vaccine recovery narrative in later 2021, these market signals could weigh on markets, being combined with the second waves in force, the faster spread of the virus, the arrival of variant strains, the logistical challenge in trying to vaccinate the world and the consequent near-term economic impact.
A pandemic such as this leaves no one unscathed. There are entire industries at risk of not returning to their previous form or which will have to downscale at the very least. Experiencing the emotional roller-coaster ride of sharply up and down markets and economies on the back of a global pandemic which has everyone concerned for their health and wellbeing, leaves questions about the longer-term impact and effects of the pandemic, both economically and psychologically.
For many, the impact of the pandemic would affect and change life in ways very different to life pre-Covid. Time will tell. Governments have assumed a far larger role in the economy, especially as markets have become very dependent on policy action and measures by the authorities since the GFC and now further reinforced by the coronavirus pandemic.
Coming years will potentially be marked by “bigger government” with policy migrating increasingly and necessarily from monetary and QE to fiscal policy measures. Covid-19 may be remembered in future as a catalyst for causing and accelerating many changes to our world.
Fabian de Beer is a director at Mergence Investment Managers