After a strong start to the month, most equity markets gave up their gains as the month came to a close. Developed market equities ended the month down 1%, although emerging markets significantly outperformed, ending January up about 3%. Initially, the global roll out of vaccinations and the promise of further fiscal and monetary stimulus helped the market to overlook concerns about virus driven restrictions. Stimulus expectations rose after the surprise Democratic sweep in the run-off election for the two Senate seats in Georgia, which completed Biden’s blue wave.
Over the month though concerns about delays to the supply of vaccines to Europe increased, raising the possibility that the “bridge over troubled waters” that we referred to in our 2021 outlook might have to be longer than expected. A group of relatively small and heavily shorted stocks also rallied strongly as a group of retail investors coordinated a short squeeze, forcing some hedge funds to close out their shorts while also selling some of their long positions.
This technically driven sell-off helps explain the slump in equities towards the end of the month and, in our opinion, is not a reason for concern for long term investors given the likely strong rebound in growth that will accompany the rollout of vaccines. Despite delays in Europe the vaccine rollout is progressing well in the UK and US and there was positive news from both the Novavax and Johnson & Johnson vaccine trials, particularly in relation to preventing hospitalisation.
Robust economic data and a moderate winter wave of Covid infections continued to support risky assets in north Asia. Strong returns from Greater China contributed to the outperformance of emerging market equities.
Defensive assets, such as high quality bonds, were on the back foot in the first weeks of the month. But as risk assets sold off, government bonds regained some of their losses, with the ten year treasury ending January down 1%.
Exhibit 1: Asset class and style returns
Exhibit 2: Fixed income government bond returns
The macro data is painting a mixed picture of the US economy. January’s flash-purchasing managers’ indices (PMIs) continued to point to expanding economic activity, with the manufacturing index at 59.1 and services at 57.5. The housing market is another area of strength, with construction starts rising in December at the fastest pace since 2006 and accelerating home prices. Property values gained 9.1% from a year earlier, which was the biggest jump since the spring of 2014. On the downside, Covid is taking its toll on the labour market again. December was the first month since April that the US economy shed workers. Consumer confidence stabilised but is still significantly below pre-Covid levels. The Democratic victory in the two Senate races in Georgia handed them control over Congress and should boost US growth in 2021. Just one week after victory, the new administration proposed a USD 1.9 trillion “American Rescue Plan”. The plan is on top of the bi-partisan USD 900 billion stimulus that was agreed in late December.
Even if the plan gets slimmed down because of the narrow Democratic majority in the Senate, the macroeconomic impact is dramatic as the overall stimulus bill for 2021 is likely to be worth close to 10% of GDP. The high amount of transfers to private households and fast implementation could lead to a significant acceleration in growth in the event of a successful vaccination campaign. For bond markets, increased expectations of government spending are putting upward pressure on long-dated US Treasury yields and for equities, an environment of moderately higher government bond yields and improving near-term growth prospects should provide support for value sectors and small caps on a relative basis.
The implications for the US dollar are less clear. Higher bond yields and stronger growth prospects relative to the rest of the world should in theory provide support for the greenback, although this may be counteracted by the impact of higher consumer spending on the US current account. The Democratic majority in the Senate also increases President Biden’s opportunity to implement climate policy as part of broader fiscal measures to support growth and speed up the energy transition of the country. This backdrop should generate opportunities for investors in several asset classes, including real assets and global renewables, all of which have rallied over the last couple of weeks.
(See our article: On the Minds of Investors– What does Biden’s presidency mean for the global climate agenda? J.P. Morgan Asset Management, January 2021)
Exhibit 3: Fixed income sector returns
Supported by a recovery in demand in both domestic and external markets, China’s economic growth kept accelerating in the fourth quarter of 2020. Real GDP rose by 6.5% year-over-year, back to the trend growth rate. China will likely be the only large economy to achieve positive GDP growth in 2020. More importantly, the recent growth is broader in comparison to previous quarters. As domestic activity has resumed, the hard-hit service sector has caught up with industrial sectors, which were the early leaders of the recovery. In December, the Caixin China Services PMI, at 56.3, was above the 53 reading of the manufacturing index, suggesting that the major growth driver has shifted to demand from consumers and private enterprises.
Trade normalisation and strong demand for health care equipment and work-from-home technology has also supported growth in China. Chinese manufacturers have been able to gain market share as international competitors have been hampered by lockdowns and supply chain disruptions. As a result, Chinese industrial production increased by 7.3% year-on-year in December, and exports rose 18.1% year-on-year, leading to a record trade surplus for the month.
China’s strong economic momentum is likely to lead to a broad-based recovery in corporate earnings. Nevertheless, subdued stimulus may put a cap on any further valuation upside in equities, which have already run up to a price-to-earning ratio of 16.8x in the past 12 months. Additionally, political risk might increase if China’s recent trade success comes under scrutiny from the new Biden administration.
Exhibit 4: World stock market returns
Sentiment and growth in the eurozone took a turn for the worse in January. The flash-composite PMI for the region declined to 47.5 and consumer confidence retreated. The weakness in activity reflects the effect of the ongoing pandemic. New and more infectious virus strains first discovered in the UK, South Africa and Brazil are magnifying the challenge for policymakers, who responded with more stringent lockdown and social distancing measures. As a consequence, a double-dip recession has become more likely. Slow vaccine rollout in the large economies of the eurozone is increasing the risk of a delay in the economic recovery.
Eurozone equities reacted with caution to these developments. An escalation of the political crisis in Italy that ended with the resignation of Prime Minister Conte wasn’t helpful for market sentiment either. Due to their higher cyclicality, eurozone equities continue to be closely linked to the trajectory of the pandemic.
After a relatively resilient fourth quarter, growth dynamics in the UK deteriorated in January. The lockdown is taking its toll on economic sentiment. The Flash Composite PMI fell sharply from 50.4 to 40.6 in January, indicating a significant hit to the economy from the latest restrictions. Nevertheless, the vaccine rollout has been relatively successful. More than 13% of the population have already received a dose vs. an average of below 3% on the continent.
The excitement in the equity markets about the last minute Brexit deal was rather short lived, which confirmed our view that Brexit is only one piece of the puzzle for UK equities. Of greater consequence is likely to be the relative performance of the UK with regards to the handling of the virus and reopening of the economy.
(See our Market Bulletin – What are the implications of the Brexit deal for the economy and markets? J.P. Morgan Asset Management, January 2021)
The news flow in January reminded us of two important things. First, governments and central banks are fully committed to support the economy with massive fiscal stimulus and very easy financing conditions. This is what we called the “bridge over troubled waters” in our 2021 outlook. The two stimulus plans in the US and ongoing supportive comments from the G4 central banks perfectly fit this narrative and give investors reason for optimism.
Second, January showed us that Covid remains a risk. New highly infectious strains and the risk that existing vaccines might be less effective against some mutations remind investors that the bridge to the post-Covid world might be longer than we all wish for, at least in some parts of the world.
After a strong run in risky assets followed by the recent pause for breath, staying cautiously optimistic but with a balanced portfolio seems sensible during this still challenging period of the pandemic.
Exhibit 5: Index returns for January 2021 (%)