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2021 Outlook: Turning points on the road to recovery
Jody Jonsson
Equity Portfolio Manager
Jared Franz
Economist
Mike Gitlin
Head of Fixed Income

With the wreckage of 2020 in the rearview mirror, investor optimism for the new year is high. After all, how could it possibly be any worse than a year marked by a deadly pandemic, a brutal recession and one of the steepest bear markets in history?


In contrast, 2021 is poised to be a critical turning point on several fronts — whether it’s the vaccine-assisted defeat of COVID-19, the resurgence of global economic growth, or the transformation of how we live and work in the digital age.


“At the start of the pandemic, who would have thought we would be in such a strong position just 10 months later?” says Capital Group portfolio manager Jody Jonsson. “We still have a long way to go and there is still a lot of suffering around the world, but we are at a point now where we can clearly see the end of this crisis and the foundations of a sustainable recovery.”



The world is turning the corner towards recovery 


Source: International Monetary Fund, World Economic Outlook, October 2020. GDP figures for 2020 and 2021 are projections. 


 


Equity markets have been predicting such an outcome for months, rallying in the face of government-imposed lockdowns and dire economic numbers. On a year-to-date basis, the MSCI World Index is up more than 11%, up to mid-December, led by surging technology and e-commerce stocks. Emerging markets stocks have done even better, fueled by China’s first-in first-out recovery from the COVID crisis.


We have seen critically important developments in relation to the rollout of the COVID-19 vaccine: The UK became the first country to approve a vaccine developed jointly by Pfizer and BioNTech with other countries following swiftly on. The U.S. Food and Drug Administration also granted emergency-use authorization for the vaccine, paving the way for mass vaccinations to begin this week in the US.


With these events in mind, the outlook for 2021 is coming into sharper focus. Many Capital Group investment professionals remain optimistic for the year ahead:


U.S. outlook: The future is here, and it’s digital


Every so often a crisis comes along that drives change at such velocity that investors can almost feel the ground shift beneath their feet. That happened in 2020 as the pandemic forced companies to prioritize and expand their online operations. Those without a digital advantage found themselves left behind.


For restaurants, hotels, retailers, airlines and small businesses, it has literally been the worst of times. At the opposite end of the spectrum, the stay-at-home era has been a boon for e-commerce, cloud computing, video streaming, digital payment processors and home improvement stores. The key question now is: How much of that activity was purely COVID-driven, and how much of it will persist in the years ahead?


A framework for evaluating COVID winners and losers 


Source: Capital Group 


 


“The post-pandemic economy is going to look very different than the one we had in February 2020,” says Capital Group economist Jared Franz. “It’s going to be more efficient and more dynamic, but there will be winners and losers. Our job as active investors is to identify them — finding the growing companies that have not only benefited from the pandemic but that also have the potential to continue generating solid growth in a post-pandemic world.”


If the U.S. can swiftly administer millions of COVID vaccines by midyear, Franz believes U.S. economic growth could rise to roughly 3% on an annualized basis. That would be one of the strongest U.S. GDP readings of the past decade.


Innovation presents opportunities across the globe


Digital business models have certainly thrived in the U.S., but we are increasingly seeing technological innovation originate and accelerate in emerging markets.


Asian companies, for instance, have rapidly adopted digital payment technologies on a wide scale and, in many respects, the West is playing catch-up. In many markets, cash is no longer king.


In some emerging markets just a few years ago, many customers had no bank accounts but did have mobile phones — and that led to faster adoption of mobile payments. In China, Alipay (part of Ant Financial) and Tenpay (run by Tencent) are dominant players. Others also have grown rapidly, including Yeahka in China and PagSeguro and StoneCo in Brazil, which provide mobile payment platforms for merchants.


 


Asia has quickly become the world leader in digital payments 


Global digital payments revenue 


Source: World Payments Report 2020 form Capegemini. 2020-2030 are estimates. Figures reflect all non-cash payments. No third party whose information is referenced in this report under credit to it, assumes any liability towards the user with respect to its information. 


 


This powerful trend is another reminder why investors shouldn’t ignore opportunities in emerging markets. While the U.S. is likely to remain a key driver of innovation, there are plenty of inventive companies across the globe. What’s more important for investors is to seek out the world’s most innovative companies in growing industries wherever they are located.


Europe outlook: stock selection remains key amid Brexit and COVID-19 risks


Governments across Europe imposed further national lockdowns in Q4 in response to a second wave of the pandemic, undermining activity in the services sector. This growth shock will put a significant dent in Europe’s economic recovery as we head into 2021.
The prospects for 2021 will depend on how quickly the pandemic subsides and the extent of further government fiscal support. Broadly, most governments are likely to maintain expansionary fiscal policy.


The UK will leave the EU’s single market and customs union at the end of 2020, raising significant challenges for the economy. Slower economic growth is likely to weigh on UK stocks, particularly retailers, banks, homebuilders and utilities that derive more of their revenue domestically. However, large multinationals such as BP, AstraZeneca and Rio Tinto may fare better due to international revenue streams.


Bottom-up analysis of companies is critical to identifying potentially attractive long-term opportunities. In Europe, assessing resiliency in revenues and companies’ ability to withstand the Brexit transition will be paramount.


Japan outlook: the country’s new leadership places digitalisation high on its agenda


In Japan, companies are often criticised for holding too much cash. But in this crisis, and similar to the global financial crisis, strong balance sheets, a strong cash position and a high equity ratio have helped support its market.


While Japan has recently installed a new prime minister, in reality, it is a continuation of the previous regime. Yoshihide Suga, who replaced his ally Shinzo Abe as prime minister, has pledged to follow his predecessor’s policies. And one of his key focuses is to digitise the country’s economy, which remains underinvested in terms of digitisation with both the proportion of people working from home and cloud penetration significantly lower than other developed economies such as the US and the UK. Collectively, this means there is a lot of scope to improve and potentially opens the door to a wide range of opportunities across business processes, consumer habits and entertainment.


Fixed income outlook: Bonds in a bumpy recovery


The unprecedented stock market turmoil of 2020 has made one thing abundantly clear: High-quality bonds are not just a source of steady and reliable income, they also perform a crucial task during times of extreme crisis.


In the opening weeks of 2020, some bond bears argued that with most U.S. Treasury yields below 2%, fixed income investments offered little value and might no longer serve as an effective hedge against stocks. Once again, these predictions proved wrong.


In the depths of the bear market while U.S. stocks, as measured by the Standard & Poor’s 500 Composite Index, declined more than 30%, the Bloomberg Barclays U.S. Aggregate Bond Index, a typical benchmark for core bond funds, did exactly what it was supposed to do. It zigged when stocks zagged, providing both diversification and capital preservation. And even as equities have recovered, bonds have held up. The benchmark was up 7.4% as of November 2020.


“In this challenging market environment, high-quality fixed income has shined,” says Mike Gitlin, Capital Group’s head of fixed income. “Anyone who held a strong core fixed income allocation should be more convinced than ever of its value — and its role in a balanced portfolio.”


Emerging market debt outlook: selectivity is key


Emerging market (EM) debt has broadly recovered from the COVID-19 shock. International capital markets have generally been open to EM, helped by significantly lower global interest rates and funding and liquidity support from the International Financial Institutions (IFIs) and sovereigns.
However, as many EM countries have followed in the fiscal and monetary policy easing footsteps of developed market countries, there is a real risk of escalating and unsustainable debt burdens in some countries. Debt restructurings in Argentina, Ecuador, Lebanon, Venezuela and Zambia have been accompanied by credit-rating downgrades in South Africa, India, Mexico, Brazil and Colombia. The starting positions for many EMs leave them with very little room to withstand new shocks.


That said, there is a large divergence within EM, with countries such as Argentina and Sri Lanka facing high external and public sector debt burdens and some of the energy exporters at the other end of the spectrum. While issues of rising debt burdens is a key area of focus, we believe that attractive valuations in an environment of a developed market growth recovery, ongoing fiscal monetary and fiscal stimulus and less aggressive geopolitics should provide a solid backdrop for EM debt in 2021.

 

Divergences within EM of fiscal and external vulnerability 


2020 public and external debt (% of GDP) 


Emerging markets are volatile and may suffer from liquidity problems. 


Sources: Public debt indicators from IMF (General government gross debt). External debt indicators from JPMorgan. As at 16/11/20. 



Jody Jonsson is an equity portfolio manager 31 with years of investment experience, 29 at Capital. She holds an MBA from Stanford and a bachelor's from Princeton. Jody is a CFA charter holder and a member of the CFA Institute.

Jared Franz is an economist with 14 years of industry experience. He holds a PhD in economics from the University of Illinois at Chicago and a bachelor’s degree in mathematics from Northwestern University.

Mike Gitlin is a partner at Capital Fixed Income Investors, part of Capital Group, with primary responsibility for leading the fixed income business. He is chair of the Fixed Income Management Committee and also serves on the Capital Group Management Committee. He has 26 years of investment industry experience and has been with Capital Group for five years. He holds a bachelor’s degree from Colgate University. Mike is based in Los Angeles.


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