A new year dawns with a heightened need for a fresh start. With 2020 now firmly behind us, we can approach this year with renewed hope and a desire to seek new and exciting opportunities. Caution will need to be exercised, but there is much to feel positive about.
Here is what we can expect from an economy on the turn, and how that will influence our investment decisions this year:
Equities may remain expensive, but opportunities do exist
There is a consensus that company earnings will start to recover this year, returning to pre-Covid levels by 2022. That could mean that equities will continue to look expensive relative to their own history, which makes finding good entry points to generate future returns more difficult. We still believe there are good opportunities out there, though, and the ongoing and rigorous analysis of our specialist teams will enable them to move quickly as these prospects present themselves. We are also confident that our current holdings are well positioned to continue generating decent returns from this asset class.
Narrowing credit spreads signal a resurgent global economy
When investors are nervous about the economy, they prefer the relative safety of government bonds over corporate bonds since there is an increased risk that a company defaults and doesn’t return on its promise. The price of government bonds therefore increases and their yields (the amount of return promised) fall. At the same time, the price of corporate bonds decreases as they become less desirable, and the anticipated return goes up to entice investors. This results in a widening of the credit spread, which is what happened at the height of the Covid-19 crisis.
However, towards the end of 2020, credit spreads narrowed rapidly, signifying a return to confidence, and we expect this trend to continue into 2021. Government bonds are yielding practically nothing, and investors are being forced to buy higher yield bonds to secure decent future returns. As these spreads narrow further, investors will need to take even more risk in pursuit of yield.
Commercial property remains important, despite office and retail sector woes
Investing in commercial property has always played an important part in a balanced portfolio since it offers a predictable income (rent) that rises with inflation. But the Covid crisis has found property investors grappling with a sudden decline in demand for retail parks and office space, as well as an accelerated change in land use. We will continue to access the opportunity in property through real estate investment trusts (REITs), which means we are purchasing listed companies that invest in property rather than the properties themselves. This improves liquidity and means we can focus on companies that specialise in sectors of the market that will continue to benefit from the pandemic, such as distribution centres, cell-phone towers and data centres.
Diversification and inflation-proofing is crucial when managing risk
Gold can be a volatile asset and this has been evident in recent weeks. But inflation remains a key risk to future returns, and gold offers some protection from that. It also doesn’t have any credit risk associated with it, which counterbalances the extra credit risk we’ve had to take in other parts of the portfolio. To ensure portfolios are fully diversified, we will also focus on absolute-return funds and infrastructure trusts, which can perform in a wide variety of market conditions. Since government spending is likely to increase, infrastructure projects can also generate yield and protect against inflation.
“It would be naive to suggest that the effects of the global pandemic are in the past. But with a portfolio of vaccines on the horizon, there is light at the end of the tunnel, and from an investor’s perspective that means a return to economic growth and business opportunity.”
Philip Smeaton, Chief Investment Officer
Investment view: five post-Covid economic trends to watch out for
With change, comes opportunity. Here are some of the key trends we are watching closely as they give rise to longer-term growth opportunities:
One of the repercussions of Covid-19 is that we are likely to see an increase in local supply chains and less reliance on imported goods from elsewhere around the world – especially China.
While this is likely to have the effect of pushing up prices (and possibly inflation), it will also help to protect domestic jobs. This trend was in train before the global pandemic hit, with the value of exports from China, as a percentage of Chinese GDP, falling from 36% in 2006 to 18% at the end of 2019 (Source: World Bank, Bloomberg).
Reduction in international travel
As businesses recognise significant cost savings from a reduction in international business travel, and employees welcome more time at home, we can expect international movement to remain subdued.
Scheduled passenger numbers on US domestic and international flights fell by nearly two thirds from September 2019 to September 2020 (Source: US Dept of Transportation, Bloomberg). If numbers don’t return to pre-Covid levels, major airlines will continue to struggle which will ultimately push up the cost of travel. The environmental benefits of this are yet to be fully understood, but this could be the catalyst we need to quantify the cost of our individual carbon footprint.
A reversal of urbanisation
Over recent years, we have seen a rapid increase in the number of people moving closer to towns and cities. This trend has been evident across urban centres around the world due to the jobs and facilities they provide. But as work habits change, and there is less need for people to locate themselves close to work, we could see a longer-term reversal of this trend.
The cost of property in major urban centres around the world has risen disproportionately over recent years, with London proving to be a good example of that. But with growth in UK house prices outperforming London prices in 2020, a reversal of this trend could help relieve a housing and infrastructure crisis and bring some balance back to a country that had become increasingly London-centric.
Accelerated adoption of technology
The future impact of technology was a given prior to Covid-19, but the global pandemic has accelerated the adoption of many technology-driven solutions such as meeting platforms and e-learning solutions, most of which are rapidly changing behaviours.
Technology stocks were the clear winners in 2020, with the MSCI World Information Technology Index returning 44% versus the MSCI World Index which returned 16%. (Source: Bloomberg). The wider repercussions of the adoption of technology will be felt across all sectors and geographies.
Increased demand to go green
The global lockdown brought home the benefits of cleaner skies and reduced carbon emissions. With an increased spotlight on climate change and sustainability, we can expect an acceleration in the adoption of green policies around the world.
Under BP’s projection of carbon emissions falling 70% by 2050, renewable energy’s share of primary energy production is forecast to increase from a 5% share in 2018 to a 44% share in 2050. Under this projection, BP forecasts that global oil production will fall by approximately 4% per annum to 2050.
The information and opinion contained in this Monthly Commentary should not be treated as a forecast, research or advice to buy or sell any particular investment or to adopt any investment strategy. Any views expressed are based on information received from a variety of sources which we believe to be reliable but are not guaranteed as to accuracy or completeness by Sanlam. Any expressions of opinion are subject to change without notice. Past performance is not a reliable indicator of future results. Investing involves risk and the value of investments, and the income from them, may fall as well as rise and are not guaranteed. Investors may not get back the original amount invested.