Without a shadow of a doubt, 2020 will go down in history as a unique year. With more than 1.6m deceased* and 72m cases worldwide, the COVID-19 pandemic first and foremost has had an alarming direct human toll. By forcing governments to take drastic confinement measures, few aspects of human life remained unaffected, and with that, the global economy suffered its most significant disruption in recent history.
Contrary to previous exogenous shocks, the global and synchronised nature of the pandemic deprived us of any form of stabilising regional decoupling, and the wide-ranging quarantines spared few sectors from fundamental disruptions, at least initially. With a sluggish economy, high levels of indebtedness and seemingly few weapons left in central banks’ respective arsenals, the initial Q1 2020 environment was an especially poor fundamental backdrop to absorb this shock – and a shock it was: global real GDP plummeted by a whopping 31% in the second quarter of 2020.
Thankfully, 2020 was also a year of human audacity and ingenuity. Within weeks of markets starting to internalise the very real possibility of economic devastation, governments and central banks courageously put together stimuli, interventions and guarantees of historic proportions, deftly enabling the financial system to remain afloat while the important medical work to combat the pandemic raged on.
In the medical field, extraordinary advances in vaccines and treatments were achieved in record time, while new and promising technologies such as mRNA were introduced to the wider public. Corporate habits adapted to work-from-home, and adoption of digital solutions drastically accelerated across all demographics.
The undeniable need for fiscal stimulus emboldened governments to finance significant green infrastructure plans, most notably in the EU, and enacting challenging decarbonisation ambitions.
All in all, 2020 was a year of records:
• The cost of protecting markets from a further drop in equities via options, as measured by the VIX index in the US and by the V2X index in Europe, equalled or even outpaced the most extreme days of 2008.
• The price of WTI crude oil reached an unimaginable USD -37 in April and remained in the low teens for weeks.
• Some developed market government bonds traded with multiple percentage points of bid / ask spreads.
• The US market saw the quickest 30%+ drawdown, followed by the quickest recovery, in 122 trading days, a sequence unheard of in modern financial history.
Numerous other records were then shattered as well on the way up:
• Apple, a unique company if ever there was one, managed to increase its market capitalisation by USD 1trn while recording little revenue growth.
• Tesla, a leader in electric vehicles with no accounting profits, added almost 500bn USD to its market cap, and now weighs more than the nine largest global auto OEMs combined.
The rush to invest in such companies, seen as beneficiaries of the acceleration of long-term trends contributed to record valuation differentials between different cross-sections of the market – a fact only marginally reversed by the post-vaccine “rotation”.
It is thus not without irony that, when writing, the final return for such a disrupted year would seem to be settling at around +15% for the MSCI World Index.
Where to from here, therefore?
As we approach the new year, we believe that key drivers of equity performance remain in place. With base effects supporting 20%+ earnings growth in major equity indices, this dynamic will likely support the view that while rich from a historical and nominal standpoint, equities will normalise to more acceptable levels when considering the low-interest-rate environment.
Significant fiscal support should remain the norm in Europe and the US as large swaths of the small and mid-cap universe, the key to national employment, remain in need of economic assistance. The presumptive US Treasury Secretary, Mrs Yellen, will likely be a strong ally, supporting expansionary policies given her track record and her well-known desire for direct stimulus to complement an over-burdened monetary policy. Further, some of these Keynesian tendencies seem to be spreading among Europe’s ministers, a welcome pro-cyclical bias which seemed out of reach as recently as a year ago.
Further, Central Bankers will remain focused on comprehensive monetary accommodation as the only way out of this historical global recession and the only path back to a 2% inflation trend, further aggravating the lack of investment alternatives and pushing valuations of visible returns. Indeed, an argument that was always dismissed as overly theoretical is now an objective reality, i.e. that the “fair” or net present value of a stream of future cash flows is sensitive to the discount rate used, itself a function of the risk-free interest rates and a risk premium.
When central banks and government vow to keep both of these as low as possible by way of trillions in stimulus, not only do financial analysts adjust their models and underwrite higher asset prices, pension funds with long term return requirements are forced, by a very real lack of alternatives, into higher-yielding assets. The asset raising prowess of private market firms such as Blackstone and the nature of their conversations with the largest institutional investors attest to this undeniable reality.
On this front, like many other matters, the current COVID crisis has merely been an accelerant and has intensified a financial context in place since the post-2008 era of quantitative easing. Should a slowly normalising economy remain supported by the stimulus of such scale, the door opens for a broadly distributed progression at asset prices, feeding into CapEx plans, consumer confidence, and an accelerating velocity of money, notably from normalising bank balance sheet quality. With large investment plans required to set the basis for a modern, greener, more efficient real economy in the developed world, could this be the beginning of a new bull market?
One of the areas of concern is ironically shaping to be the prevalence of this view, and while that does not in itself constitute a reliable enough contrarian indicator, risks of “frothiness” and the difficulty to find true attractive diversifiers will remain on our minds as we prepare to navigate, hopefully, the post-COVID world. If anything was learned in the past year, it is that exogeneous shocks and “black swans” do materialise, and while analysis and projections are useful, humility is “de rigueur”.
* Source: World Health Organization, December 16th 2020.
The views and statements contained herein, including those pertaining to contribution analysis, are those of Banque Eric Sturdza SA in their capacity as Investment Adviser to the Fund as of 21/12/2020 and are based on internal research and modelling.