What lies ahead in 2021?

What lies ahead in 2021?

The AMP Capital team give us their investment forecast for the year.

Just as 2020 was dominated by the pandemic and this determined the relative performance of investment markets and stocks, 2021 is likely to be dominated by the recovery. This in turn will have a profound effect on investment markets.

While coronavirus continues to wreak havoc in much of the world, the end result for economies hasn’t been as bad as had been feared back in March and April 2020. This reflects a combination of:

• an unprecedented and rapid fiscal stimulus that protected businesses, jobs and incomes

• debt forbearance schemes that headed off defaults and bankruptcies

• massive monetary stimulus that saw interest rates plunge and asset prices rebound

• social distancing which helped contain the virus and enable some reopening – albeit better in some countries (New Zealand , Asia, Australia and) than others.

This enabled economic activity to bounce back faster than expected as restrictions eased, even though it wasn’t always smooth and we still have a way to go to full recovery. As a result, investment markets also performed far better than had been initially feared. This has created an unusual divergence between fragile economies and frothy asset prices, with certain stocks and sectors attracting substantial inflows from investors. Members of the AMP Capital investment team give their views on key economic and investment themes for 2021.

Asset markets in 2021

BY GREG FLEMING HEAD OF INVESTMENT STRATEGY

Shares are currently performing extremely strongly, and this may well continue, at risk of a short-term correction after having run up so hard recently, although 2021 is likely to see a few rough patches along the way – much like we saw in 2010 after the recovery from the GFC. Global shares are expected to return around 8%, but expect a continuing rotation away from growth-heavy, highly-valued US shares to more cyclical markets in Europe, Japan and emerging countries.

Greg Fleming

Looking through the inevitable short-term noise, the combination of improving global growth and low interest rates augurs well for growth assets generally in 2021. In particular, we are likely to see a continuing shift in performance away from investments that benefited from the pandemic and lockdowns – like US shares, technology, healthcare and “stay at home” stocks, and safe-haven bonds – toward investments that will benefit from recovery – like resources, industrials, and eventually tourism stocks and financials.

There is a non-trivial risk that a “market euphoria” phase may develop in early 2021, with flows of cash moving out of low-yielding fixed interest into topical stocks, and in some cases into speculative momentum trading. The duration of euphoric periods varies historically, but they are usually ended by reductions in excess liquidity. It is important to closely monitor the liquidity factors currently supporting markets.

New Zealand shares are also likely to be a relative outperformer in line with global equities, helped by better virus control, enabling a stronger recovery in the near term, strong fiscal stimulus, domestic sectors like resources, industrials and financials benefiting from the rebound in growth and as investors continue to drive a search for yield, benefiting the share market as dividends are increasingly sought after.

Ultra-low yields and a capital loss element from any rise in yields are likely to result in low or even negative returns from sovereign bonds. Cash and bank deposits are likely to provide very poor subdued returns, given the ultra-low cash rate of just 0.25%. The real return from cash and deposits will be negative, or close to zero at best.

Unlisted commercial property and infrastructure are ultimately likely to benefit from a resumption of the search for yield, but the hit from the virus to space demand and hence to rents will continue to weigh on near term returns. However, easy money financing usually finds its way into property assets eventually, and this may well be the case later in 2021.

House prices are being boosted by record low mortgage rates, government home buyer incentives, income support measures and bank payment holidays, but high unemployment, a stop to immigration and weak rental markets will likely weigh on inner city areas. Outer suburbs, houses, smaller cities and regional areas will see stronger gains in 2021.

Although the NZ dollar is vulnerable to bouts of uncertainty about coronavirus and China tensions, and periodic RBNZ bond buying will keep it lower than otherwise, a rising trend is still likely toward around US$0.75 over the next 12 months, helped by rising commodity prices and a cyclical decline in the US dollar.

NZ fixed income outlook

BY VICKY HYDE-SMITH HEAD OF NZ FIXED INCOME

2020 was a remarkable year for markets and NZ fixed income was no exception. Returns were in excess of 5% over the year, a similar level to the average return seen over the past five years.

We began the year thinking global bond yields had seen their lows. Instead, the year panned out in a way few could have foreseen. Bond yields fell to fresh record lows as central banks squeezed what was left from the monetary policy sponge and uncovered new tools to shore up liquidity and force interest rates lower in response to the Covid crisis. Domestically the Reserve Bank of New Zealand (RBNZ) took the official cash rate (OCR) lower by 0.75 basis points (bps), implemented its own Large Scale Asset Purchase (LSAP) programme, and added other unconventional tools to get retail rates even lower. The resultant increase in liquidity spilled over into the corporate bond market, driving credit spreads tighter to near pre- GFC lows.

Heading into year-end and we detected a change in tone. NZ Inc. appears to have dodged a bullet with the economy bouncing back much quicker than expected. The housing market is on fire, fuelled by record low borrowing costs, and helping underpin consumer spending growth such that domestic activity appears to be completely offsetting lost output from Covid-impacted sectors. Strong demand from China is also helping our export receipts despite closed borders. A significant infrastructure pipeline will also help underpin the economy in coming years.

Vicky Hyde-Smith

While it remains to be seen whether this recent momentum can be sustained – and we wouldn’t discount the chance of a further rate cut should New Zealand return to lockdown – the bar to further rate cuts had continued to rise in our view. Front-end rates will remain anchored at around current levels through 2021 as the RBNZ stays on hold.

In terms of the global outlook, our base case is for an uneven recovery in the first half of 2021 as Covid runs rife in the Northern Hemisphere. For now, the inflation outlook remains muted and global central banks are expected to keep the money printing presses running through much of 2021. But markets are forward looking, and the odds of a more upbeat synchronised recovery have increased in recent months on the hopes for a successful vaccine and herd immunity as we progress in 2021. This should see longer-dated global bond yields continue their grind moderately higher, taking longer NZ bond yields with them as the RBNZ continues to slowly taper bond purchases. We expect inflation-linked bonds to do better in this environment.

An environment of stable-to-improving growth, low inflation and accommodative monetary policy is typically good for credit securities, although we would caution that the ability for some sectors to perform strongly from here is more limited given their strong performance in 2020. Nonetheless, falling term deposit spreads and reduced senior bank issuance – as banks tap the RBNZ’s Funding for Lending Programme to refinance maturing bonds – should continue to underpin demand and corporate bond yields for now. With the deferred bank capital changes not likely to come into effect until 2022, we expect some of this demand to be met by BBB and unrated issuers seeking to lock in low yields.

Infrastructure investment

BY JOSEPH TITMUS PORTFOLIO MANAGER/ANALYST, GLOBAL LISTED INFRASTRUCTURE

2020 will long be remembered for the Covid-19 pandemic and the associated and unprecedented decline in economic activity around the world. However, it will also be remembered for the size and speed of the response from central banks and governments globally to soften the impact on workers, companies and the population at-large.

The impact on our infrastructure, fundamental to the smooth operation of society and the economy, has varied from sector to sector and country to country. These nuances will determine the nature of the recovery not only for each asset but for the respective populations they service.

Without doubt, the significant further loosening of monetary policy and the direct or indirect lowering of interest rates was a positive development for a long-life asset class like infrastructure. The expectation that central banks will maintain such an accommodative stance well into the future – potentially beyond inflation reaching their respective targets – we believe is also supportive. Should this eventuate, the various inflation linkages in contracts and regulation provide a useful hedge for infrastructure owners.

Joseph Titmus

Within the asset class, the evolution of customer demand as a result of the pandemic was more differentiated.

Transportation and energy infrastructure were adversely affected, utilities less so and communications infrastructure on the whole looks to be a beneficiary of the disruption. The ongoing degree of fiscal stimulus, whether directed towards consumers through the provision of income support or targeted at specific industries that may have been hard hit such as airlines, will be crucial to the strength of the recovery.

Major themes we are following that will be key to the outlook include:

• Secular trends such as e-commerce penetration, video streaming, working from home and the continued rapid growth in data usage have only been accelerated by the pandemic. This has changed how we work, relax and interact and are a key driver for investments in the communications infrastructure sector (ie towers, datacentres and fibres’ network).

• Utilities around the world generally have little exposure to volumes though, given the economic downturn, demand from commercial and industrial customers was meaningfully lower. With fossil fuels often the swing producer, the share of energy produced by renewables hit record highs in many parts of the world. Investments supporting this trend are only likely to continue and perhaps even be accelerated by political developments like the US presidential election outcome.

• As well as the pandemic, a market share war between two of the world’s largest oil suppliers also caused significant turmoil in the energy infrastructure sector. This volatility focused attention on those sources of supply with long-term structural advantages and highlighted the infrastructure providing connections to the point of consumption as even more strategic.

• Transportation was at the forefront of the impact from the pandemic while also being a key player in the recovery. Subsectors less dependent on mass transit (such as freight rail or toll roads) are likely relative beneficiaries of economies reopening. Whereas other subsectors (such as passenger rail or airports) will see their recovery more dependent on the success of a vaccine.

As fundamentals continue to evolve positively across the different sectors, and with collectively supportive valuations, we remain optimistic on the outlook for the asset class.

Buy straw hats in winter

BY JAMES MAYDEW HEAD OF GLOBAL LISTED REAL ESTATE

2020 was extremely difficult for any asset class whose very existence is predicated on the gathering of people. As we all know, real estate is very much that asset class.

For a period in the second quarter the fundamental landlord and tenant relationship was challenged more than ever before as the vicious circle unfolded. Tenants couldn’t occupy their space to conduct their business, putting the responsibility of the rent into question and landlords therefore not getting what they are contractually entitled to, but for very good reason.

Needless to say, this has been a black swan event for the real estate market, but the light at the end of the tunnel is getting much closer and brighter as we migrate into 2021. The thing is, Covid will be transitory in nature for most real estate sectors. Yes it will change the dynamic of some, or pull forward structural changes in others, but not all. This means that as we push the difficulty of 2020 into the rear-view mirror and focus on a return to more normalised activity, the real estate fundamentals and earnings will also snap back, and the market is currently not capturing this in continued dislocated market valuations.

James Maydew

1. Interest rates are low and being guided by central banks to remain lower for longer. This is positive for a capital-intensive asset class like real estate.

2. We are likely to see further stimulus under a Biden administration, this will support the economy, but also add liquidity into risk-chasing capital markets. We will likely also see continued stimulus across the world, as all nations need to support their economies as they heal from the Covid dislocation.

3. With stimulus, there is a growing risk of inflationary pressures becoming a real consideration for investors for the first time in many years. Listed real estate is an inflation hedge, increasing its importance in investors’ overall portfolio strategy.

4. We are seeing an increasing number of very attractive deals to participate in. These are coming in one of two forms.

i) The strong getting stronger, issuing equity to take advantage of others’ weakness and strengthen their overall position in the market accretively.

ii) Recapitalisation of balance sheets where higher-leveraged companies, or those with a cashflow challenge due to Covid, need to issue equity to help them through what we see as a transitory period of earnings weakness, as we start to see a return to more normal times in a post-Covid world. Providing this liquidity to these companies is rewarded by a healthy margin for the risk (lower deal price).

5. Due to Covid, listed real estate is fundamentally cheap relative to all other asset classes. It has not yet fully recovered from the Covid drawdown like other sectors that were less impacted, but fundamentals and rental collection are starting to return to more normalised levels. Covid has accelerated a number of key trends we are aware of in real estate but it’s also transitory in nature for most sectors. Given the drawdown it has seen, this has firmly moved listed real estate into the “cyclical value” style bucket of the equity market. This is an area we believe will continue to see support in 2021 given the upside potential in the reversion of fundamentals (and therefore valuation) back to the norm and as investors look to add some inflationary hedges to their portfolios.

Buy straw hats in winter when no one needs them and sell them in summer when everybody needs them. This is that winter buying opportunity.

Uncertainty and disruption

BY ANDY GARDNER INVESTMENT MANAGER, GLOBAL EQUITIES

The sheer variety and complexity of challenges thrown at investors in 2020 is a valuable reminder that uncertainty and disruption are not the exception but the rule when it comes to economics and markets. While 2020 has been remarkable and devastating on many levels, it is the latest in a long line of crises that investors have had to contend with over time.

While we all look forward to a return to normal life, from an investment standpoint it is prudent to assume that we need to be building sustainable and resilient portfolios that can withstand the vast majority of shocks. Major “one time” events like Covid or progressive structural changes like technological disruption – both of which we have witnessed in 2020 – not only widen the gap between new trends and old practices, they also increase the disparity between good business models and bad ones. Therefore, it is crucial to understand how they play out between various sectors and from company to company.

Winners in this environment need to first survive the current crisis and then thrive in the aftermath. Surviving requires a strong balance sheet and the ability to earn positive cash flows to avoid depleting capital in a challenging and highly restricted demand environment. Low return, highly leveraged companies are much more exposed to these risks, particularly where demand for their products and services is more discretionary and cyclical in nature.

Those that thrive longer term are likely to be the companies able to expand their cashflows, even in an environment of impaired economic growth, and with predictable sources of new demand that are supported by structural rather than cyclical shifts.

Andy Gardner

Covid-19 will likely change the way we do things and some longer-term pathways to growth are now clearer as a result. This includes areas such as healthcare technology, enterprise cloud and software deployments, automation, e-commerce, online learning, remote working, digital technologies and electronic payments, to name just a few.

While many of the second and third order impacts relating to the pandemic remain hard to predict, we believe one thing is certain: Covid will serve to accelerate or reinforce many of these structural changes and profit pool shifts that were already underway. From a long-term perspective, and when combined with the pillars of disciplined capital allocation and strong competitive advantage, we continue to believe that these enduring trends are a more durable source of attractive long-term investment returns.

In contrast, many mature cyclical sectors face structural challenges, low returns and higher than average debt levels, and are consequently more exposed to the risks of recapitalisation and capital erosion. The costs of pivoting to address structural change – for example, taking an old economy company online – can be enormous and assets like these rarely offer more than a temporary home for capital. Investors should instead seek out the relative safety and support of long-term structural trends that allow highly profitable companies to compound their cash flows at above average rates over the long run, regardless of the economic climate.

We believe the growing gulf between winners and losers favours a targeted and active approach. One thing that the experience of 2020 has taught us is that individual company fundamentals matter more than the index, classification or label that a company has been assigned.

It is important to stress that structural growth trends (or themes) are not sufficient to drive value creation in isolation. Indeed, they can on occasion be a quick route to value destruction. Growth is only valuable if it is met with the other pillars of wealth creation: enduring competitive advantage, disciplined and aligned capital allocation and predictable business models. A