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BMO GAM multi-manager 2021 outlook

Anthony Willis, Investment Manager in the BMO GAM Multi-Manager, 15/01/2021

Looking back at 2020

“2020 is not a year we will look back on with a great deal of pleasure, it felt very different from the global financial crisis, where there were plenty of warning signs over an extended period. The sudden economic stop and subsequent financial market crash was hard to position for, and the subsequent stock market recovery initially appeared to be built on very weak foundations given the economic damage that was taking place. As ever, the need to be pragmatic and adapt saw us adding risk to portfolios as we became more confident that the worst of the economic disruption had passed, and this conviction was enhanced as news of a successful vaccine emerged.

2021 – the risks of making predictions

“As we assess the prospects for 2021, we recognise the futility of making predictions with a huge degree of conviction. However, the backdrop going into the New Year is significantly more positive in terms of a medium-term normalisation of economic activity thanks to the rapid development and rollout of the Covid-19 vaccine. The deployment of the vaccine globally will take time and significant effort, but the news of a vaccine allowed financial markets to ‘look forward’ to a return to economic growth in 2021; and if we do see a continued uptick in the prospects for more positive economic momentum we would hope to see further outperformance from the cyclical value names in stock markets, whose underperformance of the more fashionable growth names has been significant in recent years, and became even more extreme during 2020.

“In the very short term unfortunately, the news on the pandemic is however, less encouraging with the likelihood of significant restrictions on activity in countries that so far have failed to suppress the virus sufficiently to escape from enduring various levels of lockdowns and restrictions. It would appear that as the likes of the US, UK and many European countries will see restrictions extend well into 2021 and globally, travel will remain subject to significant disruption for quite possibly the whole year. The economic data shows that the services side of the economy continues to take the brunt of the pain, while manufacturing, construction and agriculture can continue relatively unaffected.

The influence of fiscal and monetary policy gets even bigger

 

“Given that many economies will be unable to operate anywhere near potential for at least the first half of 2021, it remains extremely important that governments continue to use fiscal tools to support companies and individuals impacted by the economic disruption. We hope to see fiscal policy continue to be deployed as governments transition from ‘safety net’ policies onto fiscal stimulus to boost economic activity once the pandemic begins to ease. Governments should be able to count on the ongoing support of the central banks, who we expect to maintain extremely loose monetary policy throughout the year. Questions will be asked over the impact of such policies on the longer term – a huge amount of debt has been accumulated in fighting the pandemic, adding to already high government borrowing levels. Equally central bank balance sheets have ballooned once again and are set to get even bigger as asset purchases continue. Will inflation be on the agenda in 2021? There are certainly reasons to think so – base effects alone will push inflation higher but so long as this is not sustained central banks are likely to ‘look through’ any short-term spike and we see the bar for tightening monetary policy as extremely high.

“The potential for fiscal stimulus combined with loose monetary policy is a potent mix but we are yet to fully see the appetite for politicians to have the vision to use the pandemic as a catalyst for rebuilding, and we are reminded of the damage caused by ‘austerity’ in the aftermath of the GFC when many governments failed to make use of the environment created by the central banks of extremely low rates to borrow and invest for future growth.

COVID-19 – the light at the end of the tunnel

 

“We recognise the first few months of 2021 will be tough for economies and societies as the pandemic continues; whether this begins to impact again on financial markets will depend on the continued willingness to disregard the current issues and look towards a normalisation in the second half of the year. Certainly, the pent-up demand from 2020, combined with low interest rates and generous fiscal packages should provide a significant tailwind for economies, not least if consumers have the confidence and ability to return to their normal spending habits thanks to a successful rollout of the Covid-19 vaccine. There are a lot of ‘unknowns’ in terms of our exit from this pandemic and any significant setback, be it with the vaccine or a mutation in the virus for example would likely derail risk appetite. It is also something of a concern that the consensus view on 2021 is almost universally positive suggesting a lot of good news is already priced into market levels – the broader market rally in late 2020 means that in many places at an index level many countries look expensive.

Asset allocation

 

“Our portfolios begin 2021 broadly neutral against our benchmarks in terms of our equity weighting. We do see a more positive path ahead for risk assets, or rather those many parts of the market that are more economically sensitive, whose underperformance versus high growth stocks is still close to historical extremes. As confidence builds that we will be moving into an economic recovery in 2021, supported by ongoing monetary and fiscal support we hope to see a continued rotation into some of the more beaten up names of recent years. There will clearly be economic scarring and we are not arguing that by the Spring of 2021 economic activity will be back to ‘normal’, but equity and bond markets are forward looking and there is now a path back to normality assuming the vaccine rollout is effective.

“We see huge latent potential in the value names in our portfolios and while our ‘growth’ holdings should help us through any near-team impact on risk appetite from Covid-19 headlines, we see the pent up performance in those value names as the drivers of our fund performance going forward. In fixed income, we continue to see little value in government bonds which continue to look expensive though we accept that yields may well remain extremely low given central bank asset purchases. This may be challenged however if the inflation theme gains some traction. While there is some value in corporate and high yield bonds, we think the returns from the lows in the Spring of 2020 will not be repeated.

 

Regional allocations

 

“Our strongest relative conviction remains towards Asia where economies appear to be recovering well from the Covid-19 shock and where management of the pandemic has been superior to what we have experienced in Europe and the US. We prefer Asia to the broader emerging markets though remain neutral on emerging markets overall given relatively attractive valuations and reasonable growth prospects and acknowledging that Asia makes up the lion’s share of emerging markets benchmarks anyway.

“We remain neutral on the UK for now but take comfort from the fact that the worst-case scenario of an end to the Brexit transition period without a trade deal has been avoided. The UK government will likely seek a ‘reset’ of the political agenda with Brexit now off the agenda and we should remember that with a decent majority in Parliament and limited fiscal constraints, this government has more flexibility on policymaking than we have seen for many years. We are also neutral on Europe which, like the UK, will see further economic fallout from pandemic restrictions, but also has plenty of cyclical stock names set to benefit from the recovery in 2021. Europe also faces fewer political headwinds in the short term, and indeed the agreement on Recovery Fund and long-term budget means that political dramas may be absent for some time. We remain underweight the US, which from the top down appears expensive with some uncertainty over the taxation and regulation plans of the soon to be inaugurated Biden administration. We are also very slightly underweight Japan – more of a function of more attractive opportunities elsewhere than a strongly negative view; indeed, we see the new government of Yoshihide Suga as building further on the reforms of Shinzo Abe. In fixed income, we continue to see no value in government bonds, not least if the 2021 recovery theme plays out.

Looking forwards to a return to normal, but being patient

 

“Overall, we are very aware of the short-term risks posed by the ongoing Covid-19 pandemic weighing on sentiment. But as economies recover from an extended ‘shock’ in the form of the pandemic, with a vaccine in place and with continued fiscal and monetary support, we remain of the view that the outlook for 2021, particularly for some of the cyclical and value stocks that have struggled until late in 2020, is more positive. How equity markets navigate the next few months will be determined by how far forwards investors are willing to look, and if they can ‘see through’ the short-term impact of further restrictions towards better times, and an economic recovery in 2021 underpinned by injections of stimulus from the central banks and governments, as well as of the vaccine itself. We still see headline risks in the short term given rising case numbers, against a backdrop of a stock market that appears to have a lot of good news already in the price, but with a vaccine now being rolled out there is the potential for any market weakness to be relatively short lived if investors have continued confidence over a return to normal over the course of 2021, with vaccines getting on top of the pandemic and financial assets supported by increasing consumer confidence, improving corporate earnings and a backdrop of ongoing support from fiscal and monetary policy.”

 

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