A year of winners and losers: get ready for the ‘K-shaped’ recovery

The risk curve has steepened but risk will be rewarded over defensives in the medium term.

If a single key theme emerges for investors in 2021 it will be around the geopolitical arena. There will be the new US presidency of Joe Biden, the continued effect of global tensions with China — and now the impact of Brexit finally being completed.

The big question is what central banks will continue to do regarding stimulus. Do they keep it, do they remove it, or will they head in another direction entirely and resort to macro-prudential controls in areas such as housing?

Global government debt surged by $US15 trillion ($19.4 trillion) in 2020 and this will need to be repaid. There is debate about whether austerity, reflation or default is the answer.

I believe the shape of the recovery in 2021 will be a “K”. What does a “K” look like in economic terms? Some parts of the economy prosper as we go forward, while others falter.

In other words, there are clear winners and losers from the crisis and this will become more obvious from the “K” recovery as we move further into 2021.

Australian equities finished the year strongly, having lagged substantially during the first three quarters of last year. The underperformance has largely been recaptured. The US, representing as it does 58 per cent of the MSCI All Countries World Index (ACWI), outperformed strongly in 2020. This leads me to be neutral on developed market equities.

The recent positive vaccine news has seen a shift of leadership in equity markets away from the large growth and tech companies and towards those countries, regions, sectors, and companies that have been severely affected by the pandemic and are likely to benefit most from economic recovery.

The extent to which this rotation is merely a shorter-term cyclical adjustment, or a more sustained trend, partly depends on the direction and magnitude of any movement in bond yields.

At the end of 2020, I made my big call for emerging market equities in 2021, where I now have an overweight position with more conviction.

With interest rates at historically low levels, I remain underweight or negative on fixed income as the extremely low yields now on offer do not look attractive on a risk/reward basis.

Central banks have made it clear that monetary policy will remain loose for a considerable time yet; bond yields will remain anchored for the most part.

Inflation expectations have risen but only to levels witnessed pre-pandemic. I would not be surprised to see the yield curve steepen further during the year as inflation expectations come back into focus at some point. Yet, with central banks intent on continuing to buy bonds in the open market, this will limit any fallout.

Remember, US Federal Reserve chair Powell said that the bond-buying program would continue until “substantial further progress” had been made towards the Fed’s employment and price stability goals.

Finally, the Australian dollar will strengthen against the greenback with twin deficits in the US being around 18 per cent of GDP, and as a result there is little interest rate differentiation between the US and its major trading partners. This is about the US dollar weakening versus a strengthening Aussie.

The risk curve has steepened but risk will be rewarded over defensives in the medium term.

Capital Economics is forecasting 6.8 per cent global GDP growth for 2021 after -4.4 per cent in 2020 as estimated by the IMF. NAB is forecasting 3.6 per cent growth in 2021 in Australia, after a forecast 2020 at -2.7 per cent.

In this landscape, equities do offer a combination of both growth and yield that is hard to replicate elsewhere. The generally weak earnings growth that has characterised 2020 should at least make comparatives markedly easier in 2021 as it becomes apparent global growth has returned.

Will Hamilton is the managing partner of Hamilton Wealth Partners.

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