The World Improves, But Do Markets Already Know?
By Aman Advani, Student at the University of Warwick
Investor expectations are high going into the new year. The economy should improve, the Fed is set to remain accommodative and earnings should continue to recover. Thus, stocks have a lot going for them in 2021, however, there are still swaths of weakness in the economy and hence downside risks could materialize.
This piece aims to break down key economic indicators to double down on specific investment themes in the near and long term.
The US Dollar shrinks to a 5-year low:
With the notable deterioration in the US Balance of Payments and net savings rate, coupled with the expectation that global growth will eventually rebound faster than US growth, has me to believe that the greenback will break below the lower end of a five-year trading range as the trade-weighted dollar index approaches 85.
Value small and non-US stocks (Especially EM) outperform growth, big, and US stocks:
Non-US, small cap, and value stocks have come to life and outperformed on a relative basis- a trend I expect will continue. I am not advocating selling that trio of Large Cap, US, growth stocks, but in my view this rotation will not be a one-way street, but relative cheapness of non-US, small and value – coupled with expectations of economics and earnings improvements should be solid catalysts for this to happen.
Healthcare and financials outperform energy and utilities:
While the swaths of weakness in the economy lay in the travel, leisure and entertainment sectors, many areas have benefited during the pandemic such as parts of technology and healthcare. Doing a bit of a deep dive; healthcare offers good earnings growth and reasonable valuations (assuming political headwinds don’t develop). Furthermore, financials appear very undervalued and I expect loan growth to resume, which should help boost the sector. As far as Energy and Utilities are concerned – depressed levels of demand coupled with a modest inflation and interest rate upticks make the sectors less attractive to investors.
Looking back at the past 12 years (since 2009) the U.S stock market has hit record highs every year. I don’t doubt that for 2021 either. However, I also expect that stocks will not keep pace with earnings growth of more than 20%. In other words, 2020’s stellar stock market recovery (up nearly 70% from the March low) has probably “borrowed” some from 2021. Most observers, myself included, agree that stocks are not expensive relative to other assets (chiefly government bonds), but are expensive relative to historical absolute levels.
The beginning of the year is always the time to review investment goals and adjust asset allocation decisions. Based on the aforementioned predictions, I believe that to build an income generating portfolio that provides diversified sources of risk, return and income, one should:
1. Stick with Long-term Plans
2. Look for tactical opportunities that may come from active management
3. Investments into alternative asset classes – real assets, real estate etc.
What do you think? Let us know in the comment section below!
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