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Recovery, divergence and externalities: The outlook for global equities in 2021

Giles Parkinson, global equities portfolio manager at Aviva Investors, looks at three themes that will shape the asset class in 2021.

Recovery, divergence and externalities: The outlook for global equities in 2021

1. Global economies should recover in 2021 as vaccines are rolled out and COVID-19 lockdowns ease. But with interest rates set to remain low, equities should continue to look attractive versus bonds on a relative value basis.

When interest rates are high, stock prices should be lower, because they reduce the present value of the future cashflows equity investors lay claims to. The opposite is also true; when rates are low, stock prices should be higher.

Interest rates have fallen to record lows in 2020. In mid-November, the market value of the Bloomberg Barclays Global Negative Yielding Debt Index reached a new record, $17.5 trillion, eclipsing the prior peak of $17 trillion in August 2019. A quarter of the world’s investment grade debt trades with a negative yield.

Many investors seeking returns conclude there is little alternative to equities

It is not surprising, then, that many investors seeking returns conclude there is little alternative to equities. This will likely continue into 2021 and beyond, as long as interest rates stay low. In such an environment, equities should remain attractive on a relative value basis.

2. Nevertheless, value is not evenly spread across global equities. Investors should be cautious if they continue to pile into the new “Nifty Fifty” blue-chip stocks, which are becoming overpriced.

While equities may look cheap if long-term interest rates stay low, the attractive relative valuations are not spread evenly throughout the market. Some in-demand stocks are becoming overpriced.

The current situation is reminiscent of the “Nifty Fifty” era of the 1970s

The current situation is reminiscent of the “Nifty Fifty” era of the 1970s. The Nifty Fifty were a group of premier blue-chip stocks that included Disney, McDonald’s and Procter & Gamble. They became institutional darlings in the 1960s and soared in the early 1970s, before plummeting back to earth in the bear market of 1973-74.

These stocks shared certain common characteristics: a reputation for quality and reliability, demonstrated by the ability to operate profitably in good and bad times, along with proven growth records and continual dividend increases. Eventually, business fundamentals caught up with the lofty valuations – but in the interim, they endured a savage relative drawdown that lasted two decades.

Now a new Nifty Fifty is brewing. There is no defined list, but the hallmarks are established businesses with robust competitive advantages, records of profitable growth and rising price-to-earnings ratios.

However, like their predecessors in the 1970s, current valuations for these new Nifty Fifty seem to reflect an assumption they will continue growing at their current rates forever, which is implausible in a competitive capitalist economy with the ever-present risk of disruptive obsolescence. Equity investors should be wary.

3. As the battle against climate change gains momentum under a new US administration, equity investors will need to pay renewed attention to the positive and negative externalities of the companies they hold.

Investors should always seek to examine companies’ broader impact on society and the environment – those factors known as “externalities” – through forward-looking qualitative analysis. Negative externalities include a company’s contributions to chemical pollution or carbon emissions; positive externalities bring wider benefits: examples would include a firm’s efforts to improve the energy efficiency of buildings or utilities infrastructure.

This year has seen policy shifts on both sides of the Atlantic

This year has seen policy shifts on both sides of the Atlantic. After four years of obstruction and foot-dragging under President Trump, the US is set to re-join the fight against climate change under a new administration. President-elect Joe Biden has pledged to restore the US’s status as a signatory of the Paris Climate Agreement and reverse environmental deregulation at home. Meanwhile, in Europe, stimulus packages passed as part of the European Union’s response to the COVID-19 pandemic form part of the European Green Deal.

For equity investors, these and other measures are likely to boost the prospects of renewable energy industries, which may enjoy new subsidies and stronger demand over the coming years, while major emitters could be hit with carbon taxes. We have reached a point in history where environmental externalities will start to be properly quantified and priced. Investors need to be ready.

In summary

With a vaccine on the horizon, the pandemic and the associated economic restrictions look set to ease, but many long-standing trends will continue. Equity investors have long been grappling with low interest rates, increasingly overpriced blue-chip stocks and the implications of the energy transition. These themes are set to persist – and, in some cases, accelerate – in 2021.

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