What could upset a happy New Year?
As we approach the end of an extraordinary year, investors are hopeful that 2021 would offer a better time for the global economy, which will be constructive for risk assets, such as equities, corporate credits and emerging market fixed income. We agree with this assessment (for more, please see our 2021 Year Ahead), but it is still worth considering some of the event risks in coming weeks that could introduce market volatilities.
The first is the risk of the UK heading towards a “no deal” scenario by December 31 in its Brexit negotiations with the European Union. At the time of writing, both sides are still negotiating, but differences on a level playing field for business rules and regulations and fishing rights are the main stumbling blocks. A deal to ensure a smooth transition is still in the best interests of both sides, but politics can still get in the way. In the event of a “no deal” scenario, we could see some UK financial assets exposed to the domestic economy under the greatest pressure, given the potential disruptions, but the global impact should be manageable.
Another political event after the New Year is the Georgia Senate runoff election on January 5. While Georgia has traditionally been a Republican stronghold, President-elect Biden did win this state by a razor-thin margin in the presidential election. The extraordinary amount of campaign funding and resources devoted to these two races by both parties also make the outcome highly unpredictable. The current market consensus seems to be that the Republican Party will win at least one of the two seats, hence maintaining its Senate majority. If the Democratic Party wins both seats, then we will have a 50-50 tie in the Senate, with Vice-President-elect Harris casting the tie-breaking vote. The Democrat Party would then achieve the “clean sweep” by controlling the White House, the House of Representatives and the Senate. This would imply Biden’s campaign pledges, such as corporate tax hikes, health care and energy reform, could be back on the table even though the degree of political difficulty to pass them is still significant. These legislations could potentially impact the earnings outlook and interrupt the recent sector rotations brought by breakthroughs in vaccine development.
The final event will be the implementation of vaccination programs around the world. Several vaccines have already received regulatory approval in some countries and have been rolled out to health care workers and the more vulnerable groups. These programs are expected to expand in coming months. As the vaccinated population rises, medical experts should get even more data on the effectiveness of these vaccines for different groups in the population and observe whether there are any unknown side effects. The data would also influence public confidence and impact the general public’s willingness to get vaccinated. All these factors would impact how quickly our lives can return to normal. The longer the recovery, the higher the risk of default for some financially weaker companies.
EXHIBIT 1: VOLATILITY
Despite our optimism on an economic recovery in 2021, there are always political and event risks that investors should not forget. This calls for a well-diversified portfolio. One big challenge is that developed market government bonds only offer very low, if not negative, yield and they have not offered much protection to the equity market correction in recent months. Hence, investors would need to find alternative ways to diversify their portfolios. For local political risks like Brexit, investing in a broad number of markets, such as U.S., Asia, China and other emerging markets can help. Another important principle for investors to consider will be their long-term investment objectives. Some of these risk factors may create short-term market volatility, but do not fundamentally change the long-term economic and growth prospects. Investors should then stay their courses and ensure their asset allocation is consistent with their financial objectives.