Following the
year-end rally, valuations of risk assets are marking a pause in the face of a
number of headwinds. While in our view, valuations remain underpinned by ample
central bank liquidity and the prospect, in the US, of further fiscal stimulus,
we have become somewhat more cautious about the near-term outlook.
Stricter lockdowns on the way
Further evidence of the rapid spread of the COVID-19
pandemic during the holiday period, along with the emergence of new variants of
the virus, continue to lead authorities to reimpose strict lockdowns. In
Europe, the Dutch government has extended the nation’s lockdown by three weeks
and German chancellor Angela Merkel warned strict measures may last another
8-10 weeks. France, too, is moving toward a tighter lockdown, while the debate
in the UK is focused on the need for more draconian measures. In Asia, the
virus’s impact is still being felt, with Japan declaring a ‘soft’ state of emergency
in Tokyo and the surrounding area.
These renewed restrictions, driven by worries about
pressure on healthcare systems ( particularly evident across Europe and the
US), are now expected to keep economic activity suppressed in the first quarter
and delay the expected vaccine-driven recovery.
Rollouts of vaccines so far have been slow, with end-2020
targets missed in the US and progress only starting to accelerate towards
ambitious goals in Europe. While the pace of vaccinations should continue to
pick up, risks remain elevated. These include inefficacy against new virus
mutations and mistrust among the population leading to a slow take-up.
Markets look through the politics
In the US, Democrats have passed an impeachment article in
the House of Representatives to hold President Donald Trump to account for the
violence that erupted in the Capitol. We expect markets to continue to look
through the political turmoil, however. The focus is more on continued support
from the fiscal and monetary stimulus in place, ultra-low interest rates and
vaccine distribution. Longer term, equity markets are supported by the prospect
of unprecedented pent-up demand from a return to normal lifestyles.
Last week’s wins for the Democratic Party in the Georgia
run-off Senate elections have led to greater expectations for more fiscal
stimulus in the US. We expect about USD 1trn of further fiscal support to be
enacted this year, including USD 350bn of stimulus cheques. This could push US
annual growth to above 4% in 2021.
Reflation trade is ongoing
The reflation trade has driven a selloff in US Treasuries
and pushed US 10-year breakeven rates of inflation to above 2%, driving a
steepening bias in global bond curves. Base effects are also expected to push
inflation higher, but there is little prospect of the Federal Reserve reducing
its asset purchases until 2023.
Leading Fed policymakers have reiterated that the central
bank’s accommodative stance should persist until there is substantial progress
on its dual mandate of inflation and employment.
Testing times for valuations
Against the current backdrop, support for equity valuations
is being tested. We see some scope for further rotation into value stocks amid
the prospect of higher growth and inflation. US equity risk premiums, which
have fallen to below 15-year averages, may now act as a headwind to further
gains, particularly for growth stocks. This comes on top of the possibility of
tax increases and regulation by the new Democratic-led administration.
However, a vaccine-led recovery, particularly in the
latter half of this year, could lift analysts’ earnings expectations for 2021
even further.
Similar to equities, value appears to have been squeezed
out of credit spreads by the year-end rally. In our view, fundamentals support
further limited spread compression with default rates expected to peak early
this quarter at 7% and 6% in the US and Europe, respectively.
Monetary expansion by central banks globally and US real
yields remaining in deeply negative territory continue to support gold prices.
There is scope for the US dollar’s weakening trend to continue over the course
of the year as the Fed reaffirms its accommodative stance.
Currencies that have so far lagged in the recovery, as
well as cyclical and high-yielding emerging market currencies, should
outperform amid improving terms of trade. Supportive financial conditions can
continue to benefit emerging markets alongside the rollout of more affordable
and less logistically challenging COVID-19 vaccines.
The key risk is now that the latest COVID-19 wave could
prove more severe than expected, resulting in a more protracted downturn and
further pressure on corporate fundamentals.
Any views expressed
here are those of the author as of the date of publication, are based on available
information, and are subject to change without notice. Individual portfolio
management teams may hold different views and may take different investment
decisions for different clients. This document does not constitute investment
advice.
The value of
investments and the income they generate may go down as well as up and it is
possible that investors will not recover their initial outlay. Past performance
is no guarantee for future returns.
Investing in emerging markets, or specialised or restricted sectors is likely to be subject to a higher-than-average volatility due to a high degree of concentration, greater uncertainty because less information is available, there is less liquidity or due to greater sensitivity to changes in market conditions (social, political and economic conditions).
Some emerging markets offer less security than the majority of international developed markets. For this reason, services for portfolio transactions, liquidation and conservation on behalf of funds invested in emerging markets may carry greater risk.
Writen by Andrew Craig. The post Weekly investment update – Markets resist stronger headwinds appeared first on Investors' Corner - The official blog of BNP Paribas Asset Management.
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