Executive summary

4 minute read

All aboard: from resilience to rapid recovery

There is little doubt that 2020 will go down in the history books as an extraordinary year. A deadly pandemic swept across the globe. Economies effectively shut down for an extended period to reduce the spread of the virus and limit the number of fatalities. That resulted in the largest decline in output since the Great Depression. However, while the first half of the year was punctuated by fear, that was quickly replaced by resilience and hope in the second half of the year. Resilience came from people rapidly adapting behaviours to the difficult circumstances, and hope from optimism that successful vaccines were being engineered. That hope was also founded on the rapid response of governments and central banks to both the medical and economic emergency. 

While perhaps not always perfect in terms of timing and execution, the support from the state for households and businesses was essential in preventing the debilitating economic effects of bankruptcy and unemployment. Governments correctly recognised that the cause of the crisis was not household or corporate excess, but a temporary shock caused by taking measures to contain the virus, and otherwise healthy, wellfunctioning businesses needed to be supported; household income should not be negatively impacted where workers were forced to sacrifice wages to contain the pandemic. The use of fiscal transfers, supported by central banks reducing interest rates to the effective lower bound and undertaking large-scale asset purchases, has facilitated a rapid economic recovery in the second half of 2020. 

In 2020 Q3 economies had recovered much of the decline in output over the preceding two quarters. Indeed, the bounce back in Q3 was better than we, and almost all, forecasters were expecting. As economies began re-opening, pent-up demand was released with consumer retail goods purchases rising well above pre-COVID-19 levels and services recovering in sectors where restrictions were less stringent. Interest rate sensitive areas, such as housing also saw a rapid increase in demand, and even companies began to ramp up investment again.

While hugely encouraging, the initial rebound in activity could only be sustained if there was an effective vaccine widely available for use. In early November, several pharmaceutical companies announced the results of their trials show that showed the vaccines to be highly effective. The success of these vaccine trials and the prospect of mass production and distribution starting in late Q4 is the game changer that society had been hoping for. The 'COVID-19 vaccines' section gives more detail on the next steps for vaccine distribution, but the hope now is for the majority of people in wealthier countries, as well as nearly all of the highly vulnerable subpopulations, to be vaccinated by the middle of 2021. The early and rapid roll-out of vaccines, alongside the high efficacy, is far better than anyone expected when the pandemic began. It dramatically reduces uncertainty about the outlook, allowing households and businesses to confidently plan for the future and draw down on some of the aggregate savings buffer accumulated in 2020. Moreover, it should raise demand expectations for businesses that have let inventories run down during the period of uncertainty, providing a further boost to near-term.

As a result, we see a potent combination of economic drivers for 2021: 1) economies re-opening; 2) COVID-19 uncertainty largely removed; 3) pent-up demand for those activities forgone in 2020; 4) increased savings buffer to draw down; and 5) supportive monetary and fiscal policy. We have raised our growth expectations across all the major economies for 2021 to be somewhat above the current consensus. At the global level, we expect growth to be around 6.25 per cent in 2021, following a decline of around 4.25 per cent in 2020 (Figure 1). As a result, the level of global activity surpasses the pre-COVID-19 level by the end of 2021 Q1 (Figure 2). A significant factor in that is the earlier and more rapid recovery in China. Amongst the major developed economies, the pre-COVID level of activity is expected to be reached by the end of 2021.

Figure 1. Global GDP projections
Strong growth recovery in 2021

Figure 2. Global growth scenarios
Scenario B remains our central case

Even as the global economy continues to recover through 2021, we expect monetary and fiscal policy to remain supportive. Central banks, led by the outcome of the Federal Reserve’s framework review, are expected to delay any tightening in policy until spare capacity has been eliminated and inflation has moved above two per cent for a period (Figure 3). Governments have signalled that support for household incomes will remain in place for as long as necessary through 2021 while some restrictions on businesses operating remain in place. And looking beyond the pandemic, many governments are planning to increase spending on public infrastructure, as well as in other areas, to stimulate future growth (Figure 4), including a joint effort by EU countries that is widely viewed as increasing their economic and political unity. 

Figure 3. Monetary policy to stay very loose

Figure 4. Advanced economy government deficits and debt (%GDP)

There are both upside and downside risks to that growth outlook. On the upside, if households were to recycle more of their accumulated savings from 2020 (particularly large in the United States) then consumption may rise more rapidly. Similarly, business re-stocking and investment spending could rise more rapidly than anticipated given the low cost of financing. On the downside, the resurgence in COVID cases in the northern hemisphere autumn/winter and the associated restrictions on businesses will be a drag on activity in Q4 (albeit much less than earlier in the year) and could extend into Q1. It is also possible that a greater degree of long-term economic scarring could emerge as some of the business support measures are gradually wound back, leading to bankruptcies and defaults. Finally, distribution of vaccines may prove more difficult or less effective than expected, prolonging uncertainty. 

While the prospects for growth in 2021 have improved, we do not expect inflation to rise materially over the next year. For most economies there will continue to be spare capacity throughout 2021, keeping inflationary pressures low. As that spare capacity is eliminated, and with monetary policy set to remain loose, we could start to see inflationary pressures building, albeit from a low starting point, in 2022. 

One policy area that we expect to take on increasing economic and market significance in 2021 is climate change policy. With the delayed Glasgow COP26 conference due to take place in November, countries around the world are expected to implement further regulatory and tax changes to disincentivise CO2 (and other greenhouse gas) emissions and incentivise clean energy solutions. In Europe, where the agenda is perhaps most clearly set out, there is potential for significant transitional impacts from changes in carbon taxes and other regulations. These could impact some economies (such as Germany) more than others (such as France). They will also impact certain businesses, requiring costly changes to practices. The new Biden administration in the United States is also likely to be more engaged on environmental regulation and international coordination. We see this as a key investment theme for 2021 and expand on it further in this House View.

With a rapid and robust recovery expected in 2021, in our asset allocation views we prefer to start the year with a moderate overweight to global equities (Figure 5). While multiples are already high, we expect prices will continue to be supported by the outlook for very strong corporate earnings growth in 2021; importantly, not just realised but expected earnings per share (EPS) are likely to rise. We see potential for the recent outperformance of “value” stocks to continue into 2021, as the economic recovery supports financials and travel and leisure sectors. With central banks set to keep policy rates at the effective lower bound in 2021, and maintaining quantitative easing (QE) programmes to monetize fiscal deficits, there is a limit to how much yields on shorter-maturity government bonds are likely to rise. That said, we do expect some steepening in yield curves as continuing fiscal support, alongside future growth and inflation expectations start to be priced into the market. With yields already so low by any historical standard, the benefit risk-free gilts bring from a portfolio construction perspective is also more limited. As such, we prefer to be modestly underweight duration, with a preference for UK, Italian, US and Australian government bonds over core Europe. 

Figure 5. Asset allocation summary

Both investment grade and high yield credit spreads have tightened significantly over 2020 H2, supported by central bank buying and increasing risk appetite. With spreads approaching their historical tights – Investment Grade offers just 100bps over Treasuries – the scope for material excess returns of corporate bonds is likely to be limited in 2021, but after a stellar 2020 H2, carry and rolldown will provide a more stable income. We prefer to be modestly overweight, with a preference for US and European investment grade and high yield over Asian and UK credit. In the emerging market (EM) space, we prefer hard currency debt, where spreads can tighten further on the back of the global recovery, with the high yield sovereigns more attractive. In the local currency space, a weaker US dollar would be supportive, but yields are already low by historical standards and balance sheet risks have become more elevated in some economies. 

We expect a range of factors will see the US dollar decline further in 2021, with a preference to be overweight the euro and the yen. Those factors include the upswing in the global growth cycle, during which the US dollar has historically underperformed, the reduced geopolitical tensions coming from a Biden administration, expansionary fiscal policy in the United States (alongside very loose monetary policy) and finally expanding trade and budget deficits in the US. Moreover, we do not think the market has fully appreciated the long-term implications of the increased fiscal burden-sharing in Europe, which should support the currency as risk premia decline.

COVID-19 vaccines 

Perhaps the two elements of the COVID-19 crisis which have been most consistent have been the steadily depressing acceleration in the spread of global infections, and the continual ability of progress on vaccines to meet or beat consensus expectations.

Last quarter we viewed prospects as being ahead of expectations, with the likelihood of having a successful vaccine by the end of the year. We now approach 2021 with three vaccines already having proven efficacy and with a very high probability of several more to come over the first quarter. Not only that, but the two mRNA vaccines, representing the absolute cutting edge of vaccine technology, have proven incredibly effective in reducing symptomatic infections. 

It is true that questions remain regarding the details of the 70 per cent efficacy announced by the Oxford vaccine study. However, this study, with greater depth of volunteer examination, offers the first indication that not only can vaccines reduce illness, but just as significantly they may materially reduce the spread of the virus. So, whilst the roll-out of the Oxford vaccine may be delayed by the need for further trials, the lessons learned only increase the expectations that the current Phase Three trials will result in further effective vaccines being found. This is not to say that the crisis is over, but rather to highlight that, from a position of uncertainty as to how we may be able to navigate the crisis, we now enter the well-defined logistical challenges of producing sufficient doses and then inoculating populations at speed. Whilst this will require a monumental effort, it is not quite as large as it may first appear. It is far from clear what proportion of populations are likely to be vaccinated given the extreme variations with which different cohorts experience the virus. 

However, whatever number that turns out to be, governments will not wait for all to be vaccinated before relaxing restrictions. Once the most vulnerable are protected, we should expect to see easing, even whilst younger age groups continue to receive a vaccine. In the developed world this means in many countries it is not unreasonable to expect to see normality return over the course of the second quarter. Outside of the developed world it is less clear, with production likely to take longer to reach several countries. On the positive side though, these nations have far lower proportions of their populations in the higher risk categories and so programmes can achieve much in their early stages. So, whilst logistics are challenging, the most material outstanding question is not delivery, but is one that we won’t have any clarity on for some time: the longevity of protection. 

It will take some time before we see whether and how the efficacy of vaccines wanes over time. The evidence regarding natural infection is reassuring, with protection appearing to be long lasting for the vast majority. We will now have to wait and see the degree to which vaccines can match or even exceed this longevity. Whilst this uncertainty hangs over us, given the low level of mutation observed thus far, it is unlikely that the downside scenario is materially worse than the prospect of annual booster shots to revitalise population immunity levels.