Multi-Asset Solutions Monthly Strategy Report
Global markets and multi-asset portfolios
EXHIBIT 1: MAS ASSET CLASS VIEWS FROM DEC STRATEGY SUMMIT
BEYOND THE PANDEMIC: POLITICS, POLICY AND MARKETS IN 2021
2020 will forever be infamous for the coronavirus pandemic, and the imprint of this shared global experience will be felt for many years to come. But last year we also witnessed a number of critical events that in any normal year might have dominated news flow. The fiercely contested U.S. election, the ebb and flow of Sino-American trade tensions, and Brexit will all have profound and lasting implications for investors. In this article we take a welcome, if temporary, step away from COVID-19 related issues and explore what might unfold in 2021 for the Joe Biden presidency, how the relationship between Washington and Beijing may evolve, and the prospects for the UK and Europe post-Brexit.
What investors might expect from the Biden administration
We expect the incoming Biden administration to focus its near-term efforts on virus recovery, both by improving vaccine distribution and by steering another fiscal stimulus package through Congress. On the stimulus, Biden will first attempt to work with congressional Republicans, which will limit the size of any bill. If that fails, congressional Democrats will work alone through the budget reconciliation process, which requires only a simple majority and would thus likely allow for a larger package. We already expect above-trend growth in the U.S., especially from the second quarter onward. Reinforcing existing stimulus could turn that into a boom.
Although Democrats control the White House and both the House and Senate, their narrow congressional majorities, along with the centrism of several Senate Democrats — not to mention Biden’s own instincts — will constrain any sweeping initiatives. We expect the administration to push for tax increases at some point, in part to help fund its spending goals in areas like infrastructure and climate. But we think most of these tax hikes will need to be modest to win legislative approval. For example, the statutory corporate tax rate, lowered in 2017 from 35% to 21%, may rise again, but likely not beyond 28%.
The Trump administration devoted considerable attention to China. Here we anticipate continuity of broad aims, though not necessarily of means. We expect the Biden White House to continue pressing for changes in China’s behavior, especially in the areas of market access, intellectual property protection and forced technology transfer, but without relying on tariff hikes and perhaps taking fewer company-specific actions. Overall, we think China policy will become more multilateral and, as a result, probably slower-moving.
Trade war redux or a change in tactics?
In particular, trade policies under a Biden presidency are likely to be more favorable for Asia than they were under the Trump administration, in our view. The U.S. is now likely to adopt a more multilateral approach to trade, with more predicable policy actions, leading in turn to diminished uncertainty around trade. This should support business sentiment in Asia, especially in China. It should also help to boost manufacturing capex in the region, which has been dragged down by rising U.S.–China trade tensions and the COVID-19 crisis.
That said, we do not think the Biden administration will fundamentally change the U.S.–China relationship. It is difficult to see a U.S. reversal of the recent hawkish trends in China policy, given the increasingly negative views on China in the U.S. We see the strategic rivalry between the two countries as a structural trend and believe U.S.–China tensions will persist in the coming year, albeit perhaps below the surface. While we do not expect further escalation of U.S. tariffs against China in 2021, we believe removal of existing tariffs and restrictions in the technology sector and capital markets are unlikely to be a top priority for the new administration. Lingering tension between the two countries should continue to drive production of mainly low-end, labor-intensive sectors to relocate away from China to other parts of Asia, benefiting economies such as Vietnam and India.
In short, we look for a more stable and predictable relationship to emerge between Washington and Beijing, even as the rivalry between the two superpowers persists. The reduced tail risk of a flare up in trade tension and tit-for-tat sanctions is positive for risk sentiment, not only in China but also in other key elements of the supply chain — notably parts of Europe.
The skittish isles: learning to live with the Brexit withdrawal agreement
Just as trade sentiment is improving across the Pacific, trade relationships across the Straits of Dover are under some pressure. While the UK and the European Union (EU) succeeded in agreeing an 11th-hour deal to avoid a hard Brexit, the scope of the agreement is rather limited — and, it’s becoming clear, somewhat complex. Over time, initial issues related to the movement of goods should be ironed out and logistical bottlenecks cleared. However, discussions around the services sector, which accounts for 79% of the UK economy, and in particular finance — almost 7% of the economy — are only just beginning (Exhibit 2).
UK-EU discussions around the dominant services sector have only just begun
EXHIBIT 2: UK economy: Real GDP by sector, 1997-2018 (%)
Avoiding the huge disruption of a hard Brexit has breathed some life into pound sterling but further upside in GBPUSD above the upper 1.30s is likely to be constrained by easy Bank of England policy. Persistent weakness in the pound should lend some support to UK stocks, which earn over 70% of their revenues overseas. Buoyant commodity prices further bolster an index with heavy weightings to resources and energy sectors. As one of last year’s weakest performing markets, the UK’s FTSE has the potential to continue catching up to other global indices. However, we’ve seen only the first chapter in the UK’s post-Brexit relationship with the EU, its largest trading partner.
Now that the theatre of deals and deadlines is behind us, cooler, more technocratic heads could work towards a more palatable relationship that allows both the UK and EU to thrive. But the Brexit process from 2016 to 2020 strained trust on both sides and any enhancement to the UK-EU trading relationship will likely take some time to forge. So while the immediate removal of risks mitigates some important left tail risks in UK assets, the structural upside case looks less convincing.
ASSET ALLOCATION IMPLICATIONS
Overall, we maintain a pro-risk stance with a positive outlook on the global economy in 2021. The new stimulus package signed into law in late December reinforces our view that the U.S. economy will grow solidly above trend this year. And while we expect oil prices and base effects to lead to a jump in headline inflation in 2Q21, core inflation is likely to remain contained and monetary policy accommodative. Globally, the surge in virus counts in Europe will limit activity in the first quarter but, equally, vaccine roll outs are accelerating. By mid-year we see scope for a surge in pent-up demand – especially in travel, leisure, retail and tourism – which means that for the year as a whole, growth should be above trend. Asian data are robust and even allowing for some virus related concerns in the near term, we expect the recovery to persist.
The positive macro view and expectations of persistent policy support translate to a positive view on stocks and on credit, which is reinforced by our quantitative models. Bond yields have recently risen and while our quant models favor a meaningful duration short, the level of ongoing central bank support probably keeps a lid on yields. As a result our books are either neutral or mildly underweight bonds, depending on their overall risk exposures. On balance, we prefer to express our positive view on growth through an overweight to equities or credit, rather than through an underweight to duration.
Our credit exposure is well diversified and at this point we are playing mostly for carry rather than spread tightening. Within equities we favor cyclical exposure and achieve this with overweights to emerging markets, U.S. small caps, Europe and Japan. Despite high valuations we would not count out U.S. large cap stocks quite yet, and maintain a mostly neutral exposure. However, as the recovery broadens out, there will be greater scope for other regions to catch up to the U.S.
In the near term, we see some signs that market consensus has moved to adopt the pro-risk stance we first adopted in the second quarter of 2020. However, price action does not suggest that positioning is especially crowded just yet. Some sell side survey data and sentiment signals are beginning to sound notes of caution and we heed this by judiciously trimming risk when assets have rallied. However, we believe that the case for further upside in risk assets in 2021 is still strong. As a result, we maintain our positive tilt in our multi-asset portfolios.