It seems almost surreal that riskier assets have done so well (over the short-term), despite the growing COVID-19 outbreaks that have forced many governments to introduce lockdown measures. Equity markets continued to rally in December and emerging market equities rose significantly benefitting from renewed hopes of a cyclical recovery. Commodity prices (excluding Oil) were broadly flat in 2020 as sharp falls in the first half of the year were followed by a strong recovery in the second half due to rising demand from China. Domestic equities delivered a 9,8% return over the 4th quarter of 2020, outperforming both domestic bonds and cash. Various positive developments drove equity market momentum in the last quarter of 2020 –
The stellar performance of riskier assets has masked some underlying vulnerabilities within the global economy, and as we start the year, we think it is wise to consider some of the key issues that investors may have to grapple with, as they review their investment portfolios.
According to the 2021 World Bank Economic Review, the global economy is entering a decade of disappointing economic growth outcomes. Past recessions are usually followed by several years of disappointing growth outcomes and downgrades to growth expectations. It is interesting to note, that economic growth fell well short of expectations, in seven out of ten years following the global recession of 2009. What causes economic growth disappointments? Recessions leave long-lasting effects that are often underestimated – depressed capacity utilisation, discouraged investment because of weak growth expectations and loss of human capital due to persistent unemployment. What does this mean for investors? The biggest implication may be to the inputs of strategic asset allocation. Many investors use long-term investment returns as the basis for their expected long term asset class returns. GDP growth is considered a crucial driver of investment returns. Over the previous decade, growth disappointments have contributed to a lower return environment, and investors will need to take a long hard look at whether equities, in the long-run, can still deliver a return premium above the risk-free rate.
It is a commonly held view that the COVID-19 pandemic has had an adverse impact o aggregate demand, and that inflation risks are to the downside over the short-term. This will give central banks further license to continue asset purchase programmes and keep interest rates at record low levels. However, we should not forget that there has been a supply shock due to the pandemic – this introduces inflation upside risk in the long run. This explained through the law of supply and demand. If there is a decrease in the supply of goods, while demand remains the same, then prices tend to rise. In the current environment – productivity enhancing investment has plunged, depressed capacity utilisation is discouraging further investment which may to a legacy of obsolete capacity and expectations of weak growth may further depress investment. Supply chains and working arrangements are also going through costly changes. All these factors may contribute to a lower level of aggregate supply in the long-run, which introduces inflation upside risk. What does this mean for investors? The exceedingly rare event of low a growth environment coupled with high inflation cannot be discounted – investors should start to identify the asset classes that may perform well during such environments - and there are few!
High debt levels – this is a global problem, and not a South African specific issue. In 2019, global total debt reached a historic record of 230% of GDP, while government debt rose to 83% of GDP – now this was in 2019, before the pandemic. The fiscal stimulus aimed at supporting economic activity, because of the impact of the pandemic, has led to record fiscal deficits. As a result, global government debt is expected to rise to 100% of GDP in 2021! Why is this a problem? Because the past episodes of rapid debt accumulation often ended with a financial crisis – this is according to a recent study by the World Bank. What does this mean for investors? We think that asset allocation will have to be more selective to avoid economies with weak fiscal positions and a high reliance on external support to finance fiscal deficits.>/p>
Scenario analysis is an essential element of our research – this is where we blend investment insight with the discipline and transparency of a quantitative framework, to capture the complex relationships that exist in financial markets. Firstly, we assessed the current environment and went back in time to find periods which were like today’s environment, to understand the type of asset class returns that investors may expect. We found a few such periods with recovering GDP growth, low inflation, and risk-on attitudes from investors. In most of such periods, equities outperformed all other asset classes over a six-to-twelve-month horizon. Secondly, we studied the 12-month period after previous global recessions, of which there are only four – and in all these periods, equities outperformed the other asset classes. The common denominator? If central banks continue employing asset purchase programs and while monetary policies stay accommodative, then equities have a particularly good chance of continuing their momentum in 2021 – despite all the vulnerabilities we have highlighted above. These policy measures, by the central banks, have been effective at stabilising financial markets, but they also create excess liquidity – which often ends up in financial markets, fuelling positive momentum in riskier assets. History as they say, may not repeat itself, but it often rhymes. We hope you have had a restful period and we wish you all the best for the current year.
Lima Mbeu Investment Managers (Pty) Ltd is an authorised financial services provider in terms of section 8 of the Financial Advisory and Intermediary Act, 2002, FSP number 49018, Registration No 2017/399814/07. This document is for information purposes only. Past performance is not indicative of future performance. The information contained herein is derived from sources which are believed to be reliable. Any opinion expressed herein is based on the presenter’s current analysis and is subject to change. This presentation does not constitute an offer to sell or a solicitation to buy any security. Lima Mbeu has a conflict of interest policy which outlines how conflicts of interest are managed. This policy, as well as additional information about Lima Mbeu’s products, is readily available upon request or on our website: www.limambeu.co.za
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