Global Market Overview – 4th Quarter 2020
So, it’s finally over… 2020 will likely go down in the history books as one not to be repeated. It started with the impeachment of an American president, followed by a global pandemic that infected tens of millions and is on track to kill more than 1.6 million at last count, and was then accompanied by a global recession and resulting bear market reminiscent of the Great Financial Crisis. Finally, were this not enough for the stoutest of heart, a level of social unrest took hold across the US that harkened back to the protests of the late 1960s. This all unfolded against the backdrop of a presidential election contentious enough to hear fears of civil conflict openly discussed. It is hard to imagine another year in recent times that equated to the events that plagued 2020. Yet, despite all of this, markets ended the year remarkably higher, which is a testament to the promise of science and the innate human tendency to believe that everything will work out in the end. In the fourth quarter, equity markets continued to rally for the third consecutive quarter and significantly outperformed fixed income. The US election result and positive news on Covid-19 vaccines helped more cyclical segments of the market to recover. Value stocks rose by 16% and had their best quarter since 2009. Even more spectacular was the performance of small caps, which returned 24%, erasing the underperformance vs. large caps for the year. Growth equities gained nearly 13%, underperforming over the quarter, but are still ahead by a wide margin for the calendar year. Rising commodity prices were driven by strong demand for industrial metals in Asia. Oil prices also rose, aided by the vaccine news.
The pandemic took a turn for the worse over the quarter. New infection rates rose significantly in Europe and the US, topping the previous highs. Limits to intensive care unit capacity and outbreaks in nursing homes forced governments to implement new stringent lockdown measures to slow the spread of the virus. In Europe and the UK, services are under pressure from the restrictions. In the US, the vicious autumn wave of the virus began with a time lag to Europe and the restrictions were less stringent.
Therefore, negative effects on US GDP growth are likely not to be seen until Q1 of 2021. Manufacturing continues to show more resilience to the pandemic than the service sector – a trend that can be observed globally. Recovering demand for goods and lower sensitivity to social distancing, helped to keep manufacturing purchasing managers’ indices (PMIs) in expansionary territory. This is good news for equity markets, since goods and manufacturing still contribute significantly to index-level earnings.
Concerns over the rising caseload were overshadowed by the announcements from PfizerBioNTech, Moderna and AstraZeneca/Oxford in November, that their vaccines were effective in reducing symptomatic cases of Covid-19. An end to the Covid-19 crisis now appears to be in sight, but the path to recovery may still be bumpy over the coming quarters.
After approval by the authorities, how quickly these vaccines can be manufactured, distributed and administered on a mass scale will be crucial. It is worth noting the logistical challenges of the Pfizer/BioNTech and Moderna vaccines, which both require cold storage and are relatively expensive. Success will also depend on the willingness of the population to get vaccinated and the effectiveness of the vaccines against any mutations in the virus.
For equity markets, the vaccine announcement on November 9 led to one of the largest momentum changes in history. Hard-hit value sectors, such as energy, traditional retail, hotels, airlines and financials rallied, while the pandemic winners, such as online retail, health care and home improvement, lagged.
From a regional perspective, emerging market equities rose nearly 20% and Asia ex-Japan returned almost 19%, both benefiting from renewed hopes of a cyclical recovery, a falling dollar and increasing global trade activity. Strong demand for medical supplies and tech products lifted Chinese exports to the highest monthly nominal level on record in November. South Korea, another beneficiary of increased technology demand, also showed accelerating momentum in its export industry, with the new export orders PMI jumping to 54.6 – the highest level since March 2011 – in November.
US stocks reacted positively to the election result, which contributed to the 12% climb for the quarter. The prospect of a less confrontational presidency under Joe Biden, together with a divided Congress that might prevent both tax hikes and a tightening of regulation for technology and health care companies, pleased the markets. Nevertheless, the Democrats still have a shot at completing a blue wave if they manage to win both Senate seats in Georgia in the run-off election on January 5, which could change the narrative. US growth stocks, which have benefited from the shift online caused by Covid-19 this year, underperformed after the positive vaccine news.
The last days of the year brought long-awaited relief for pandemic-stricken companies and households. US lawmakers in Congress finally agreed on a pandemic relief plan that will extend many of the CARES act support measures, including renewing direct payments to households and more generous unemployment benefits. Consumer spending was potentially at risk without further government support, making this an important step for the US economy in building a fiscal bridge to the other side of the pandemic.
After the leaders of Poland and Hungary had effectively blocked the European Union’s recovery fund and seven-year budget because the funding was conditional on upholding the rule of law, EU governments finally found a compromise. This paves the way for a EUR 1.8 trillion financial support package, provided it is ratified by the national parliaments of the 27 member states. It was agreed that a significant proportion of the budget and recovery fund has to be spent on sustainable and green
projects. The EU also agreed tougher climate goals for 2030, increasing the reduction in carbon emissions it is targeting vs. 1990 levels from 40% to 55% by 2030. This will lead to significantly higher investments in renewable energy and more regulation.
On the monetary policy front, the European Central Bank (ECB) increased the size of its planned asset purchases by EUR 500 billion to EUR 1,850 billion, and extended the horizon over which it will make these purchases by nine months to the end of March 2022. The caveat was added that purchases can be terminated early, if no longer needed, or extended, if needed. This is helping to keep bond yields down in the eurozone going into the new year, despite the expected large amount of gross government bond supply due to pandemic relief programmes. Less of a headline but still important was the fact that the ECB asked banks to limit dividend payments until September 2021 to support the stability of the financial system.
In the UK, the Bank of England announced that it would expand its asset purchase facility by a further GBP 150 billion. The US Federal Reserve also explicitly committed to purchase at least USD 80 billion per month of Treasuries and agency mortgage-backed securities until the committee feels “substantial further progress” has been made towards its inflation and employment goals.
In the UK, house prices and November retail spending were up year on year, despite severe restrictions on activity. Nevertheless, the bigger picture is that GDP remains substantially lower than its February level leaving plenty of room for recovery once the vaccines have been rolled out. The quarter ended with a Brexit deal finally being agreed, helping sterling to rise 5% over the quarter. UK equities delivered over 12% for the quarter.
The first quarter of 2021 is likely to remain challenging for the global economy. Disappointing economic data is likely to coincide with continued pandemic-related restrictions. So far, the market has broadly been willing to look through the near-term weakness thanks to the vaccine news and policy support measures but any disappointment on the vaccine front could lead to increased market volatility.
In what proved to be one of the most volatile years in recent history, characterized by the worst recession in living memory, South African equities ended the year 7% higher. As with its global counterparts, the local equity market exhibited one of the sharpest recoveries in history, thanks to the emergency monetary easing and fiscal support from government that ultimately prompted risk taking, even in the most challenged domestic sectors.
Of course, the bifurcation between the “stay at home stocks” and those geared towards the real economy was eye watering, especially for those invested in the latter, but the turnaround in the 4th quarter provided some much-needed respite. The FTSE/JSE All Share Index gained 9.8% in the last quarter.
The main drivers of the reversal that put value stocks back on the front foot in Q4 was twofold:
• First, we saw the approval of multiple COVID-19 vaccines, all with efficacy rates of 90% or more
• Secondly, Joe Biden was elected as president of the United States and although Republicans still control the senate, there is heightened chance that the Democrats will control both the house and senate after the Georgia run-off.
The potential for more spending along with higher taxes, under a Democrat controlled house and senate has already seen inflation expectations increase, resulting in a steeper yield curve, and a weakening US$. Higher rates typically put pressure on growth companies because their valuations discount future earning way into the future. Further fiscal stimulus is also positive for depressed segments of the market, like energy, banks and property stocks.
This strong shift in sentiment was supportive for those cyclical areas of the market that had largely been left behind, especially for local financials and listed property companies which delivered 19.5% and 22.5% respectively in the last quarter. Consumer cyclicals also were major winners in Q4 with Mr. Price, Foschini and Pepkor achieving returns of 31%, 24% and 21% respectively.
JSE heavyweight Naspers (and Prosus) have not performed nearly as well over this period (as it did in the first half of the year). Not only has the translation impact of the strengthening rand been a factor, but so has the antitrust probe into Tencent by the Chinese government which has spooked investors. The Naspers/Prosus buy-back program has of course offset some of this bad news and the companies still eked out gain of 2% and 4% over the quarter.
The resource sector has been exceptionally strong this year (+21%), with the gold and platinum counters benefitting from the strong improvement in their terms of trade early in the year (strong spot prices and a weak rand). The third and fourth quarter was characterized by industrial metal producers and diversified miners taking the lead as the real economy continues to re-open, especially with China ramping up industrial production significantly. The FTSE/JSE Basic Materials Index gained 8.7% over the quarter.
The bond market ended the year on the front foot, with strong foreign demand for nominal bonds despite the obvious challenges facing South Africa’s fiscus. The FTSE/JSE All Bond Index delivered 8.7% for the year, and 6.7% in the fourth quarter. With local rates now offering negative real yields, government bonds have become an obvious choice for income investors who can afford to take more risk. All eyes will be on Treasury in the coming year, who face a seemingly impossible task of reigning in the budget deficit, but at the same time shifting spending to lift economic growth.
In economic data, local inflation for the 12 months ending in November came in at 3.2% which is still comfortably at the bottom end of the SARB’s target range. Savers will be happy with the low inflation we have seen recently, but one should keep in mind that low inflation in this environment also reflects how weak the domestic economy is. In the coming months, higher food prices and lower petrol prices should balance each other out, but as the economy recovers, most economist expect an uptick to the middle of the range as we approach the second half of 2021.
Fourth quarter economic data points to a further improvement in the growth for Africa’s most industrialized economy, albeit at a slower pace than we saw in Q3. Economic output is by no means on a straight path to pre-Covid levels, with many sectors slowing just as others appear to be gaining momentum. Data released in December (for October) indicates that mining, trade, and motor sales were all weaker in October while manufacturing and building activity improved. Other economic indicators such as manufacturing and economy wide PMI’s recorded a slowdown in November, as did the BankservAfrica Economic Transaction Index.
In the coming months, all eyes will be on the performance of leisure related sectors over the festive season, especially considering government’s last-minute efforts to curb the spread of the 2nd wave and free up capacity at hospitals, most of which are currently full. From a Covid perspective, we are by no means out of the woods yet, especially with the discovery of new variants in SA (and globally) which scientists still know little about. The worst possible scenario at this stage is if the vaccines due to become available in the first half of the year are ineffective in treating the new variants. A more stringent lockdown that is broader than the current adjusted level 3 is also a risk, but the government seem to be more aware of the balance between lives and livelihoods than they were going into lockdown in early 2020.
After sustaining an unprecedented shock from COVID-19 early in 2020, the global economy is ready to get back to normal in 2021 with the help of one or more vaccines. We expect modest, if uneven, improvement in economic growth, low interest rates and ongoing monetary and fiscal policy support in 2021. While the promise of a better 2021 is at least partially priced in, accommodative policy and a snap back to normal in distressed service industries can help investors earn solid returns in the coming year. We see more upside than downside risks to our constructive outlook for 2021, but very near-term risks skew to the downside as the vaccine is rolled out in the face of new virus variants. The main risk to our positioning would be a continued worsening of the coronavirus pandemic that could spark additional lockdowns and curbs on economic activity. We could see regional limitations, but national restrictions remain unlikely. We’re expecting financial markets to return to a (relatively) more normal environment in 2021. But getting there will be precarious, and “normal” will also bring with it the continued reality that yields will be low, valuations may be full and returns could be tough to come by. But, as always, investors’ long-term plans, goals and needs remain unchanged.