By Tim Wishart
Investors could be excused for being utterly perplexed by what has happened in financial markets over the last 18 months.
I’m sure that if anyone had possessed a crystal ball that had stated clearly that the world would soon be enveloped in a medical crisis and that the global economy would be about to suffer its weakest period since the end of the Second World War, then the natural inclination would have been to sell most of their investments and retreat to the sidelines.
In hindsight, that would have been a painful mistake. The powerful performance from most assets of the last year would have been missed, and given the rise in valuations and prices, that Nostradamus would now be scrambling to find a re-entry point into those investments that they had sold. It has been as confusing and contradictory a period in financial markets as we have ever known. For those who hoped 2021 would provide definitive answers, I’m afraid there is disappointment. To try and plot a path through the years ahead, we will aim to answer the three key questions that we believe investors should be asking.
When will the economy fully recover from Covid-19? The basic facts are the global economy is about to go through a period of relative boom, certainly by comparison to the woes of 2020. A combination of unprecedented government and central bank stimulus mixed with pent-up consumer demand should create a potent cocktail for economic activity that will lead to very strong growth over the next year or so.
We are expecting the global economy to make up all the lost ground to Covid early next year, with various parts of the world recovering at different speeds.
By way of analogy, we liken the global economy to a four-engine jumbo jet. Right now, the first engine in the US is firing on all cylinders; the Chinese engine fired up again first and is steadily chugging away; Europe and the UK are just starting to accelerate, while parts of the emerging world are spluttering. As we move into the second half of the year, all should be operating nicely and the jumbo should be flying high, even if there is the occasional patch of turbulence.
Does the economy no longer matter to financial markets? In our view, financial markets have already priced in a very positive economic tomorrow and one can certainly put together a cogent argument that markets have moved “too far, too quickly”, thereby outpacing the economic reality.
The improvement we have seen in financial markets is down to two factors. Firstly, the support from the government and central banks, including unprecedented levels of asset purchases and record low interest rates, has encouraged (forced) investors to take more risk.
Whilst we would argue that the authorities’ actions have been the pre-eminent driver of asset prices in the last year, one cannot totally ignore the fact that the economic future looks relatively bright and there should be a period of strong growth for the world ahead.
How strong economic output will ultimately be will depend on how quickly consumer confidence can fully recover, and upon how committed governments are to chucking around money that they don’t have. If this money is spent wisely, something that has been sadly all too rare in previous bursts of fiscal spending, then we could see markets and economic activity both benefit in the coming years. What we would then expect to see in such a scenario is that economic fundamentals will once again become the primary driver of financial market performance, whilst central bank activism hopefully takes a back seat.
How should I position my investment portfolio for the decade ahead?
We have long expected the 2020s to be the “Turbulent Twenties”. We felt that the pressures of high debt loads, greying demographics and the most pronounced levels of financial inequality in history would lead to volatile economic, political and financial market outcomes. We also continue to believe that we will experience higher levels of inflation uncertainty ahead. Because of this view, we continue to stress the importance of balance and diversification in any investment strategy. Nobody can say with any certainty what lies ahead. But we can say where there is value in a world of expensive assets.
The good news is that there are several attractive growth themes that we can embrace for our clients. Chief amongst them are the energy revolution and medical development, both of which should benefit materially from future economic trends.
Governments and companies appear to be moving quickly down the path of renewable energy, from which there is no return, while Covid will inspire an acceleration in the golden age of medical technology, which should bring rich rewards to investors.
We would also urge all investors to be global in their approach.
Right now, we do see good relative value in UK equities, but some of the best opportunities that we can pinpoint are in the Far East, with both Asian consumption and Japanese corporate change acting as two of the structural long-term investment themes within our portfolios.
The former is a tale of sustainable long-term growth, while the latter is a case of realising value from inefficient Japanese companies, who are being forced to reassess how they manage their assets after three decades of lacklustre performance.
When it comes to fixed income investing, the paucity of future returns and concerns over rising interest rates are probably the key hindrances to prospective returns and the major reason why many investors are simply giving up on bonds.
In our view, there are a range of exciting and enticing opportunities still available across global fixed income markets, such as asset-backed securities, specific corporate credits and emerging market debt, with potential returns of 3-6% per annum still viable over the next five years.
It would still be very easy to throw one’s hands in the air and declare that investing is too hard. As tempting as that might be, it would likely be just as wrong as it was a year ago. We would reiterate a message of “don’t give up, but do think differently”. We believe that such a mantra can lead to success, regardless of what the world throws at investors. As the experience of the last 18 months has shown, that could be anything.
Tim Wishart is head of Scotland and the north of England at Punter Southall
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